In the modern economy, inflation tends to remain at the level of its "historical" rate.
If, for some time, prices systematically increase, e.g. by 6%, people get used to the expectation of such a rate. The expected inflation rate is embedded in various economic institutions.
Trade unions and directorates write contracts calculated on a 6% inflation rate, the government's strategists are mounting this price increase into their fiscal and monetary policy, and a 6% inflation premium is embedded in interest rates. Six percent is the expected rate of inflation (sometimes it is called anticipated, basic or indigenous).
An important feature of expected inflation at a moderate pace is that it may persist for a long period. As long as the same rate of inflation is expected and ratified by the central bank, by fiscal policy, by investors, consumers, trade unions and company directorates, there is no reason why inflation could not be maintained for a whole year at a rate of 2 or 4 or 7%.
Fully embedded in the economy, inflation corresponds to a certain neutral equilibrium, a state that can persist at a rate of 2 or 4 or 7% for unlimited time. Usually, however, the rate of inflation is not constant. It is changing from the decade to the next one, even from year to year. The economy very often suffers from shocks that push inflation out of its current path. These are, for example, high or low unemployment, sharp increases in oil prices, failure of the war. When such shocks hit the economy, inflation rises above or falls below its expected rate.
Measures of expected inflation: at least three methods are used to measure expected levels of variables such as inflation:
- A group of people asking about their expectations
- Using the hypothesis of rational expectations, in accordance with which people's expectations correspond to optimal forecasts, and then applying statistical techniques to calculate optimal forecasts.
- Inference about what people think about based on market data.
- Schmeling, M., & Schrimpf, A. (2011). Expected inflation, expected stock returns, and money illusion: What can we learn from survey expectations?. European Economic Review, 55(5), 702-719.
- Ang, A., Bekaert, G., & Wei, M. (2008). The term structure of real rates and expected inflation. The Journal of Finance, 63(2), 797-849.
- Thomas, L. B. (1999). Survey measures of expected US inflation. Journal of Economic perspectives, 13(4), 125-144.