What is the role of expectations in creating inflation, and how can central banks prevent these expectations from getting worse?
Answer (1)
Expectations play a powerful role in creating and sustaining inflation. When people believe that prices will continue to rise in the future, they act in ways that can actually cause inflation to increase. This is what economists call a self-fulfilling prophecy.Here’s how it works: If consumers expect prices to go up, they spend now instead of later to avoid paying more in the future. This sudden rise in demand can push prices higher. At the same time, workers demand higher wages to prepare for higher costs of living. Businesses, expecting higher costs from wages and materials, raise prices in advance. This cycle is called a wage-price spiral, and it happened in many countries during the 1970s—including the U.S. and parts of Asia.In the Philippine context, when news of inflation spreads—like rising oil prices or food shortages—people expect tricycle fares, sari-sari store prices, and market goods to increase. This behavior leads to hoarding, price hikes, and demand surges, making inflation worse even if supply is stable.To stop this, central banks must control expectations. The Bangko Sentral ng Pilipinas (BSP) does this by:Communicating clearly – They announce their inflation targets (usually 2–4%) and explain what actions they are taking, like raising interest rates.Taking credible action – If BSP says it will fight inflation but does nothing, people won’t believe them. But if they raise rates quickly, it shows they are serious.Maintaining independence – Because BSP is not directly controlled by politicians, it can act in the best interest of the economy.In summary, what people believe about the future affects their behavior today. Managing expectations is one of the most powerful tools central banks have. When people trust the bank, inflation stays low and stable—and that’s good for everyone.
