Chapter 2: Managing Expectations: Inflation and Monetary Policy

Inflation around the world reached multidecade highs in 2022. While headline inflation has since come down, core measures are proving stickier. The high inflation experience of the last two years could engender persistently high inflation expectations, complicating central banks’ paths to getting inflation back to their targets. Chapter 2 summarizes recent developments in inflation expectations across economies, agents, and horizons. Empirical analysis uncovers an increasing role of near-term inflation expectations for inflation dynamics. Using a model-based approach, the chapter finds that inflationary supply shocks are long-lasting and monetary policy is less effective when expectations are backward-looking. However, improvements in monetary policy frameworks, including communication strategies, can help to better inform agents’ expectations and to bring inflation back to target more quickly and at a lower output cost, complementing standard cyclical policies.