Comments: Inflation expectations steady

How well do you think these surveys measure 'true' inflation expectations?

It seems to me that the notion 'inflation expectations are well anchored' is inconsistent with households leveraging up to purchase assets.

Plus, firms' inflation expectations clearly aren't well contained.

Posted by Sell Everything at June 26, 2007 08:46 PM

Well, the Bank clearly thinks they mean something, or else it wouldn't collect and publish its own surveys. The leveraging point doesn't really apply - people can believe that general inflation will stay low but house price inflation high, simply because that's been the experience of recent years.

I think if you measured firms' inflation expectations they'd also be low. My view is that the "return of pricing power" is mainly a pass-through effect.

Posted by David Smith at June 26, 2007 09:11 PM

I didn't mean that these surveys are meaningless, as you seem to suggest. Just that their usefulness might be limited.

I also believe my point about leveraging is valid. Mortgage costs account for about 20% of household income. So to exclude them from 'general inflation' seems a bit odd. Households could respond to rising house prices by pushing for higher wages. But I won't labour this point to try and avoid this becoming another HPC thread!

Finally, I disagree that 'if you measured firms' inflation expectations they'd also be low'. What we're seeing now, with pricing intentions in most business surveys spiking higher, might well be a pass through of energy prices. But, as Mervyn King has pointed out on several occasions, if firms were truely confident in the inflation target being achieved, they would absorb the rise in energy costs by pushing down on other costs (primarily wages) rather than in the form of higher prices.

Posted by Sell Everything at June 26, 2007 10:03 PM

Fair point - I was making the distinction between the individual and the collective - which is quite a common feature of surveys. In other words, if you ask firms what they expect to happen to inflation overall, they'll probably give you an answer close to the 2% target. But if you ask them what is going to happen to their own prices, they'll probably give you something higher.

Posted by David Smith at June 27, 2007 08:40 AM

Dear David,
To the extent that the MPC set interest rates with the aim of hitting the target up to 2 years ahead, it is indeed worrying that the long-term inflation expectation of consumers is 3.5%. One would expect the expectation to be a weighted average of the target (2%) and the past history of inflation. Clearly, 3.5% implies that consumers currently place more than 100% weight on past inflation. An indication that the MPC should be more backward looking.
Many thanks.

Posted by Costas Milas at June 27, 2007 10:12 AM

Hi Costas

The absolute value of theses questions is a bit irrelevant. After all they ask what is your expectation of inflation.

My expectations are above 2%, even though I fully expect the MPC to hit 2% CPI, basically because I don't believe the CPI measures inflation for the individual, and so I use the RPI as my "inflation".

Posted by kingofnowhere at June 27, 2007 01:04 PM

Obviously, the MPC considers the above expectations (I am not judging how reliable these are) as well as inflation forecasts produced by External Forecasters. A detailed analysis is available from:
http://www2.warwick.ac.uk/fac/soc/economics/staff/faculty/wallis/publications/bsw3_final.pdf
Many thanks.

Posted by Costas Milas at June 27, 2007 02:07 PM
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