For most economic commentators the underlying driving force of inflation is inflationary expectations[1]. For instance, if there is a sharp increase in the price of oil, individuals may form higher inflationary expectations that could set in motion spiraling price inflation, or so it is held.
If somehow expectations could be made less responsive to various price shocks, then over time this would mitigate the effect of a price shock on price inflation, it is argued.
If we were to accept that inflation expectations are the driving force of the inflationary process, is there a way to make these expectations less sensitive to various price shocks?
Most commentators are of the view that by means of suitable central bank policies it is possible to bring peoples inflationary expectations to a state of equilibrium.
At this state it is held expectations are perfectly anchored or not sensitive to changes in various economic data.
According to various economic experts once inflationary expectations become anchored, various price shocks such as sharp increases in oil or food prices are likely to be of a transitory nature. This means that over time price shocks are unlikely to have much effect on the rate of inflation.
Note that what matters in this way of thinking is the underlying price inflation. It is for this reason that Federal Reserve policy makers and many economists are of the view that to be able to track the underlying inflation one must pay attention to core inflation – percentage changes in the consumer price index less food and energy.
To make inflation expectations well-anchored individuals must be clear about the monetary policy of central bank policy makers. According to this way of thinking as long as individuals are unclear about the precise goal with respect to inflation that policy makers are aiming at it would be difficult to bring inflationary expectations to a state of equilibrium.
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