Managing Expectations: Inflation and Monetary Policy

Inflation around the world reached multi-decade highs in many economies in 2022. While headline inflation has since come down with monetary policy tightening, declining commodity prices and improving supply chains, core inflation remains elevated. Some observers have expressed concerns that the higher inflation experience of the last two years could engender high and stickier inflation expectations, complicating central banks’ paths to getting inflation back to their targets. This chapter first summarizes recent developments in inflation and inflation expectations across economies, agents (professional forecasters, households, firms, and financial market participants), and horizons (near- and long-term; degree of anchoring). Then, using a mix of empirical and model-based analyses, it studies the channels and contributions of expectations to recent inflation dynamics and assesses how the shape of the expectations formation process may influence monetary policy effectiveness and vice versa.