What is the importance of inflation expectations, and how can central banks manage them?
Answer (1)
Inflation expectations refer to what people believe will happen to prices in the future. These expectations are important because they can influence actual inflation. If people think prices will rise, they act in ways that make inflation happen—they spend money quickly before prices go up, and workers demand higher wages. This causes businesses to raise prices to cover wage costs, leading to a wage-price spiral.That’s why managing expectations is a major goal of central banks like the Bangko Sentral ng Pilipinas (BSP). When the BSP signals that it is serious about keeping inflation low—such as by raising interest rates or issuing strong statements—people feel confident that inflation will remain stable. This helps avoid panic buying or wage demands that push inflation higher.For example, if oil prices spike due to global conflict, people might expect prices of goods in the Philippines to also rise. But if the BSP assures the public that it will use its tools to control inflation, and follows through by adjusting monetary policy, it can stop expectations from getting out of control.In the early 1980s in the U.S., inflation expectations were high. The central bank, led by Paul Volcker, raised interest rates significantly to show the public that inflation would be controlled. It caused a short-term recession but restored long-term confidence in the economy.In the Philippines today, the BSP maintains inflation targeting, which helps guide expectations. They regularly announce inflation forecasts, explain their actions to the public, and adjust policy as needed.In short, if inflation expectations are well-managed, it helps maintain price stability, encourages smart spending and investment, and keeps the economy healthy.
