The sensitivity criterion states that although near- and medium-term inflation expectations may respond to economic shocks, expectations of inflation far in the future should not. Well-designed monetary policy will generally allow for some response to shocks of short- and medium-term inflation expectations in order to balance competing objectives, but long-run inflation expectations should not be affected. In a formal sense, this criterion is about the very long-run response of inflation to shocks, but as shown in my research with Orphanides, the beneficial effects of anchored expectations on macroeconomic performance only occur when the inflation response to a shock is not expected to extend over many years. As Keynes admonishes us, in the long run we are all dead, and the notion of long-run expectations cannot be too long. This sensitivity criterion requires long-run inflation expectations to be invariant to shocks. In contrast, the level criterion applies the more stringent standard that the rate of long-run inflation expectations be consistent with the central bank’s long-run inflation target. In other words, it demands that expectations not just be anchored, but anchored to the right spot. These first two criteria are present in the FOMC’s statement on Longer-Run Goals and Monetary Policy Strategy, which stresses the anchoring of longerrun inflation expectations at the target level and recognizes that short-run trade-offs between inflation and economic activity may arise. The third criterion—uncertainty—requires that uncertainty about future inflation increases less than linearly with the forecast By continuing to use our site, you agree to our Terms of Use and Privacy Statement.
Similarly, “breakeven inflation” measures derived from inflation-indexed Treasury securities are based on the CPI and include time-varying risk and term premiums in addition to expectations of inflation.8 To address the lack of direct comparability of different measures of inflation expectations, I compare readings over the past two years to the levels observed during 2014-2020, after the FOMC’s announcement of a 2 percent long-run goal and before the onset of rising inflation in the spring of 2021. The level of longer-run expectations in the SPF has consistently stayed very close to the FOMC’s 2 percent goal. The other measures have generally stayed within pre-pandemic ranges, with most recent readings only slightly higher than corresponding average levels from 2014-2020. The upper portion of Table 1 provides statistics on these comparisons. Interestingly, during the period of sustained low inflation before the pandemic, the market-based and Michigan measures declined, and their current levels are similar to those seen prior to that decline. Assessment of the uncertainty criterion for well-anchored inflation expectations is more challenging given data limitations. In theory, prices on inflation options contracts could be used to infer investors’ distributions of beliefs about future inflation.9 However, there have been virtually no trades recorded in the U.S. market for inflation caps and floors since 2015. Over that time, the “prices” reported for these options were based on models—not transaction prices—and cannot be used to measure investors’ inflation uncertainty during the current episode.