ECON 101
Inflation expectations By Robert Eyler
I nflation
based on research by economist S. Boragan Aruoba. This graph shows how month- to-month expectations change and reshape the short-term, medium-term and longer view. Notice that as inflation has decreased in the short term, the June 2023 and June 2024 expectations are vastly different over the next 24 months (toward summer 2026). Still, the long- term expectations were similar each month, one year different. The May 2024 expectations were slightly higher than June 2024 over the long term. Labor markets are deeply intertwined with inflation expectations. Due to the lag
expectations shape the way people
make decisions. From plumbers to policymakers, we all think about the future and what that future will cost when consuming, saving or considering a policy choice. The sale and purchase of commodities—such as fuel, gold, copper and wheat—are all connected to seller and buyer expectations about
While inflation decreased in the short term, the June 2023 and ‘24 expectations are vastly different over the next 24 months.
inflation. The sale and purchase of bonds and equities use inflation expectations to determine an expected “real”— aka inflation-adjusted—profit for financial investments. This is one of the key differences between accounting and
in labor contracts compared to macroeconomic events, negotiators must anticipate future conditions when deciding on new labor agreements. Employers are wary of how inflation expectations can influence demand for
economics in practice: Investors will consider inflation expectation as an erosion agent on profitability. In other words, when inflation expectation rises, the purchasing power of profits is undermined, regardless of the accounting profit. Financial markets generally track inflation expectations through bond markets and what investors are willing to pay for
their products and the wage demands of workers. Workers, on the other hand, are keen to maintain their purchasing power when they trade their time for wages. The theoretical link between inflation expectations and wages is clear in economics, but the data reveals a complex interplay among inflation, wages, unemployment and expectations. Consumer inflation is significantly influenced by the cost of housing, and periodically by fluctuating food and energy prices. Policymakers tend to focus on “core“ inflation—but for the average person,
How the economic crystal ball can influence decision making
government bonds with different maturities. Because the assessed risk in government bonds sold by the United States government to finance fiscal deficits is the same core risk, the main difference in interest payments to the bondholders is the current inflation expectations and the dangers such inflation may pose to the real revenues coming from a bond’s interest payments. This is why you may have bond yields in the short term exceeding those in the longer term: short-term inflation expectations may be higher than longer-term expectations. The accompanying graph shows those expectations and their changes based on a model at the Philadelphia Federal Reserve, called the ATSIX (Arouba Term Structure of Inflation eXpectations)
the price of eggs, bread, milk, steak, gasoline and rent is more reflective of their everyday life. As we approach the presidential elections, the actions of the Federal Reserve, the latest inflation data, and the Federal Reserve’s decisions on interest rates will become great debates at American dinner tables and in the 2024 election. Our expectations of change drive many of these decisions and activities across our economy. g
Dr. Robert Eyler is professor of economics at Sonoma State University and president of Economic Forensics and Analytics in Sonoma County.
August 2024
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