Expectations of future inflation are a key driver of short-term price movements. When estimating inflation, policymakers assume these expectations are rational and made based on full information. Yet, recent survey data covered in a Bank of Canada working paper, shows that this is far from the case.
Instead of using Central Bank communicated information, households and firms are more likely to base expectations on personal consumer experiences. Not only does this make individuals forecasts more varied, it also makes them susceptible to structural changes, such as greater price discrimination by large retailers using big data.
Given the large disconnect that exists between inflation expectations and those assumed by policymakers, new statistical methods are needed. In addition, Central Banks should re-think the methods they use for disseminating key policy information.
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