Before turning to the focus of this talk – the measurement of household inflation expectations – I want to provide a quick summary of market-based and professional surveys. The difference in yields between nominal and real government debt can be used to derive a measure of market inflation expectations for the price index used to protect the holders of real government debt from inflation. In the United States, that price index is the consumer price index (CPI). Thus, if the nominal 10-year yield is 3.5 percent and the real 10-year yield is 1 percent, one crude measure of average CPI inflation expected over the next 10 years would be 2.5 percent. Further, if the nominal 5-year yield is 3 percent and the real 5-year yield is 0.2 percent, then a crude measure of average CPI inflation expected over the next 5 years would be 2.8 percent and a crude estimate of the 5- to 10-year forward average CPI inflation would be 2.2 percent. BIS central bankers’ speeches  1  I say crude because such calculations ignore any difference in liquidity between and within the two types of debt, any compensation investors require for the uncertainty of the real value of nominal coupon securities and a variety of other issues, such as the fact that Treasury Inflation-Protected Securities (TIPS) are indexed to the CPI with a time varying lag. There are numerous ways to measure inflation expectations that take into account liquidity differences.
Indeed, since 1998, the median forecast from this SPF question has stayed within a very narrow range. However, the amount of disagreement around this median has increased recently. Much of this increase is related to lower forecasts for the 10-year average. During the past decade many central banks have begun to explore ways to improve through surveys their measurement and understanding of the public’s inflation expectations. At the New York Fed in November last year we had a conference where many different aspects of this research were discussed. In addition to initiating new surveys and gradually moving from traditionally qualitative to more quantitative questions and measures, research is being conducted to analyze the quality and information content of survey-based measures of consumer inflation expectations. In late 2006 at the New York Fed we initiated a major research project to examine a number of issues: First, what is the best way to measure the public’s inflation expectations in terms of inflation concepts and forecast horizon? Second, how do households form and update their expectations of future inflation: to what extent are they based on past inflation experiences and what information sources do they rely on? Third, do people act on their expectations and if so, how? My remarks today will mainly focus on the first set of issues, but I will conclude with some preliminary research on the other two.