The IMF assessed the impact of inflation expectations on actual price increases

An increase in inflation expectations leads to an equivalent increase in inflation in developed countries and a less pronounced, but still significant, increase in developing countries, according to data from the International Monetary Fund’s analytical review on monetary policy. The fund is concerned about the prospects for higher inflation expectations consolidating and points to the importance of not only transparent monetary policy, which reduces the level of uncertainty, but also a stable fiscal position of states, which is associated with lower price expectations.

Rising inflation expectations amid a surge in inflation after 2021 last year affected both developed and developing countries, but long-term expectations (for a period of more than five years) are still stable, according to the analytical chapter of the International Monetary Fund’s macro forecast update on monetary policy. The study provides data for the US, euro area, UK and Brazil, but notes that this discrepancy is also confirmed in a wider sample of countries. However, long-term expectations have a weaker effect on inflation (this effect is visible when the yield on bonds with a shorter maturity is lower).

The authors’ model shows that an increase in expectations for the near future by 1.1 percentage points in developed countries translates into an equivalent increase in inflation; in developing countries the impact is more modest – the same expectations increase it by 0.8 percentage points due to a longer lag. When adjusted for the opposite effect (that higher inflation accelerates expectations), the effect is more modest for both groups – for developed countries it is 0.8%, for developing countries – 0.4%.

Historically, expectations change slowly—on average taking three years (and even longer for core inflation that excludes commodity and energy prices)—and real rates in 2022 were on average lower than in previous episodes before tightening cycles began. high inflation, but now they are higher than average—rapid tightening of monetary policy is traditionally seen as a remedy against the consolidation of high inflation expectations.

In the case of the 2021-2022 inflation surge, expectations initially did not play a significant role – prices rose against the background of economic recovery after the pandemic, increased demand with disrupted supply chains and rising prices for energy and raw materials – but over the past quarters the role of expectations has been growing, they record at the IMF. For developing countries, the impact of expectations is less significant, but deferred price increases have more weight.

On average, stable inflation targets and more transparent policies of monetary regulators can increase the share of economic agents paying attention to monetary policy (and not to past experience of price increases). The authors also point to the role of fiscal policy – the worst-case scenario for inflation involves a high level of debt and a chronic budget deficit. Fiscal stability, on the contrary, is associated with lower expectations of price growth, the IMF notes.

A long fight against inflation means higher losses for the economy, but the wait for policy easing by leading central banks, expected to be as rapid as rate hikes, is gradually being delayed: neither tightening targets nor restrictions have been achieved – inflation remains high, and an almost universal decline in business activity is not yet accompanied by a pronounced cooling of the labor market in developed countries.

Tatiana Edovina