WASHINGTON – If you think inflation will go up, it could be a self-fulfilling prophecy.
You might demand bigger raises to pay for more expensive gas, groceries, rents or other things. And that behavior, in turn, can make inflation worse.
If, on the other hand, you feel pretty comfortable that inflation won’t flare up in a big way, you might go about your business – for the most part – as you usually do.
Those “inflation expectations,” the mind-sets of both the public and investors about where prices are heading, play an important role for Federal Reserve policy-makers in their efforts to tame inflation.
“Undoubtedly, the state of inflation expectations greatly influences actual inflation and thus the central bank’s ability to achieve price stability,” Fed Chairman Ben Bernanke said Tuesday. It was a mostly academic speech to a conference of the National Bureau of Economic Research. Yet it shed light on the role consumers and investors play in influencing the country’s economic well-being.
If investors, consumers and businesses feel confident that the Fed will keep prices stable, Bernanke suggested, they may be less inclined to act in ways that could aggravate inflation. He also said that people may be less inclined in such circumstances to worry that inflation will eat away at investments and paychecks, and might feel better about longer-term financial planning.
Bernanke’s remarks, in Cambridge, Mass., were made available in Washington.
“Experience suggests that high and persistent inflation undermines public confidence in the economy and in the management of economic policy generally,” he said.
And that can hurt “risk-taking, investment and other productive activities,” Bernanke added.
On Wall Street, investors – unnerved by disappointing forecasts from Home Depot and Sears and oil prices that briefly spiked over $73 a barrel – sent stocks tumbling Tuesday. The Dow Jones industrials fell nearly 150 points.
Stable inflation is good not only for the economy but for the pocketbook. Out-of-control prices can eat away at paychecks, investments and standards of living. And getting it under control through interest rate increases can be difficult and painful.
In his remarks, the Fed chief didn’t say anything specific about the future course of rates in the United States.
The Fed’s key interest rate has held steady at 5.25 percent for just over a year. Before that, the Fed had pushed rates up for two years to fend off inflation, the longest stretch of increases in the central bank’s history.
At the Fed’s last meeting on June 27-28, Bernanke and his central bank colleagues noted that although there has been some improvement in recent inflation barometers, they were not ready to declare victory.
Indeed, they said the biggest risk to the economy was if inflation failed to recede as they anticipated.
Bernanke’s remarks Tuesday touched on the challenges of measuring inflation expectations, and he said additional research would be welcomed.
“If the public experiences a spell of inflation higher than their long-run expectation, but their long-run expectation of inflation changes little as a result, then inflation expectations are well anchored,” he explained.
“If, on the other hand, the public reacts to a short period of higher-than-expected inflation by marking up their long-run expectation considerably, then expectations are poorly anchored, he said.
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