It is hard to disagree that a vast number of macroeconomic issues and challenges can negatively affect the lives of ordinary people, the performances of various organizations, and the overall economic state of a country. One such problematic concept is inflation, and when studying this primary macroeconomic phenomenon, researchers highlight the interconnection of realized inflation and inflation expectations. The former can affect the latter, and vice versa, meaning that both these concepts should be considered carefully. The purpose of this paper is to analyze an article that discusses this macroeconomic topic.
The article selected for this analysis is a thorough, peer-reviewed research by Binder and Kamdar (2022). The authors explain the ways that inflation expectations are set and can mutually influence realized inflation, highlighting the importance of this theme by stating that “the conduct of modern monetary policy relies on an understanding of inflation expectations” (Binder & Kamdar, 2022, p. 132). Overall, there are two approaches that may explain how expectations are formed: rational and adaptive ones. Thus, when inflation expectations are rational, they “incorporate all information that is useful in forecasting future inflation” rates, considering interest rates and other factors that can somehow affect the macroeconomic phenomenon in question (Binder & Kamdar, 2022, p. 135). At the same time, the key focus of adaptive expectations is on the past rates of realized inflation and the factors that caused it. While this approach also considers current circumstances, Binder and Kamdar (2022) notice that it generally leaves “readily available information about the subsequent course of inflation” unused (p. 135). Interestingly, according to the authors, the shorter the period of prediction, the less accurate these predictions are. In other words, it is easier to identify expected inflation over long periods of time than for the next year.
One should mention that the examples and cases provided in the article make the understanding of the topic better and prove the author’s statements. For instance, when demonstrating the interconnection between the anticipated and actual rates of inflation, Binder and Kamdar (2022) describe employers and their workers. If the latter expect high inflation, their actions can contribute to the realization of these predictions. Consider they ask their employer to raise wages; after the company does that, it decides to increase prices to compensate for the higher salaries. As a result, the expected inflation rates become realized precisely because they were expected (Binder & Kamdar, 2022). On the contrary, increased inflation levels during previous months or years can affect people’s anticipations. This knowledge is essential in order to be able to control this interconnection and probably influence the realized rates of inflation by correcting individuals’ predictions.
The reason why I selected this article is that the importance of inflation cannot be overestimated, and I decided to learn more about this phenomenon. When I saw the title of the study, I was intrigued by the division between expected and realized inflation, and getting acquainted with the examples and cases provided by the authors was when I made my final choice. This is a detailed yet concise and understandable discussion of the interconnection of the two concepts, and I believe that more people should be aware of this mutual effect to be able to control inflation. One of the most interesting points I gained from the study is that it is more effective to orient on both past tendencies and current information when making assumptions about how inflation will change in the near future. Finally, after these predictions are made, it is of vital importance to consider all the possible consequences before taking action – precisely one’s precautious measures can cause the expected inflation rates to become realized.
Reference
Binder, C., & Kamdar, R. (2022). Expected and realized inflation in historical perspective. Journal of Economic Perspectives, 36(3), 131-156.