Expectations are critical for monetary policy transmission These differences reflect, to a considerable degree, the role that expectations are assumed to play in consumption and investment decisions. Put simply, the more households and firms believe that the past is a good guide for the future, the less powerful monetary policy will be. Inflation expectations are a case in point.
If they are adaptive, meaning they change in response to actual inflation outcomes, inflation will become more persistent, and monetary policy will transmit more slowly. Carefully analysing how inflation expectations evolve is therefore critical for understanding the strength and speed of policy transmission. At present, the long period of above-target inflation raises concerns about a potential shift in inflation expectations.