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Inflation expectations and the strategy review

How people expect prices to develop in the future influences how they spend, borrow and invest money today. That in turn affects the economy and is therefore important for our monetary policy. If we understand people’s inflation expectations better, we can make more informed decisions.

Why were inflation expectations part of our strategy review?

What we mean by stable prices

Our job is to keep prices stable. We do this by making sure that inflation – the rate at which the overall prices for goods and services change over time – remains low, stable and predictable.

We aim for a 2% inflation target over the medium term. Price increases should be small enough so as not to create problems for people and businesses. But they should be large enough to avoid the bad scenarios that may unfold if inflation falls too low.

Our commitment to this target is symmetric. That means we view inflation that is too low just as negatively as inflation that is too high. Both are equally undesirable.

People’s expectations matter

The level of inflation today can influence how people expect prices to develop in the future. If shoppers and business owners get used to inflation being very low or too high, they come to expect that it will stay that way. These expectations are important. People use them to make decisions about spending, borrowing and investing. Businesses also keep these expectations in mind when setting the prices for their goods and services.

Once these expectations move away from the inflation target of a central bank, it can become difficult for the central bank to steer the actual development of prices in the economy back to that target. The central bank can help avoid people forming such expectations by having a clear target and keeping inflation close to it. That is why the Governing Council discussed the important role of inflation expectations as part of the strategy review.

Whose inflation expectations matter to us?

Different people have different expectations

How prices change not only depends on the countless decisions that businesses and people make in the economy every day, but also how they expect prices to develop in the future. But different groups of people, whether experts trading in financial markets, business owners or citizens, can have different inflation expectations.

In the past, central banks have often focused on the inflation expectations of market participants, as well as those of experts who respond to special surveys, when making decisions. One reason for looking to these groups was that their expectations were readily accessible. There was not as much reliable information about how businesses and people expected prices to change in the future.

Everybody’s inflation expectations are important

But everybody’s inflation expectations are important. That is why central banks are putting a lot of effort into getting a better idea of how these different groups expect prices to develop. That helps us make more informed decisions. At the ECB, for instance, we have a new survey in which we ask people their opinions on inflation and areas of the economy. This information feeds into our analysis and, ultimately, our actions.

How does our new inflation target help with people’s expectations?

It is easily understood

Our new target of 2% inflation is simple, clear and easy to communicate. People understand it. That will help us towards ensuring people’s expectations of how prices will develop in the economy are in line with our new inflation target. This in turn helps us keep prices stable.

Inflation expectations and their role in forecasting
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