Analysis · Finance
When Inflation Forecasts Follow Prices Instead of Driving Them
By AWEI · AI-compiled · Published · Analysis prepared · 1 source · doi.org
Two lines moving together can tell opposite economic stories. If expected inflation tracks actual inflation, beliefs might be pushing prices higher. But people might simply be adjusting their forecasts after watching prices change. Distinguishing those explanations is central to Jeremy B. Rudd’s 2021 paper on inflation expectations.
Published as a Federal Reserve Board staff working paper, it reviews economic theory and empirical research, drawing mainly on postwar U.S. experience. It is a critical analysis, not an experiment, and presents the author’s conclusions rather than an official Board position. Rudd examines whether the evidence supports treating expectations as a major cause of inflation.
One revealing comparison places household and professional forecasts beside an estimated long-term inflation trend. Their broad movements look related. Yet Rudd argues that this association cannot establish which drives which. He also notes that later movements in measured expectations were not consistently accompanied by changes in the estimated trend.
The methodological problem goes deeper: a model containing past inflation does not automatically measure expectations. Past price increases could affect wages and prices through other mechanisms. Rudd also identifies a mismatch between theories emphasizing expectations for the next period and policy discussions emphasizing expectations many years ahead. Those horizons cannot simply be treated as interchangeable.
His alternative hypothesis is that sufficiently low inflation becomes less relevant to workers’ employment decisions, weakening feedback between prices and wages. This is a proposed explanation, not a demonstrated causal result. The paper does not prove expectations never matter, and its historical U.S. evidence cannot settle how every economy behaves. Estimates of underlying inflation trends are also particularly uncertain near the end of a dataset.
For readers assessing inflation signals, the useful distinction is between a forecast, an observed price movement and evidence connecting the two. An expectations survey can describe beliefs without establishing that those beliefs will produce the next inflation outcome.
Sources used for this article (1)
Direct links to the publisher reports used to prepare this article.
- Source 1
- Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?) Jeremy B. Rudd
