Sarah Hunter, the Reserve Bank’s chief economist, has given a speech about “inflation expectations” at the Citi investor conference in Sydney on Wednesday, drawing on new research from the central bank.
Here are four takeaways:
What are inflation expectations and why do they matter?
We anticipate a lot of things, such as the weather, and (often) modify our behaviour and clothing accordingly.
So it is with inflation. If people experience rising prices, they assess – with some caveats – how they think about future prices and make adjustments. Those changes might be to ask for a bigger pay rise or to set a higher price for goods or services if they’re in business.
And, as Hunter said, expectations can be self-fulfilling:
“Macroeconomists generally think that a prerequisite for consistently achieving low and stable inflation over time is well anchored inflation expectations,” she said.
“That is, people across the economy believe inflation will generally average a low rate (in Australia’s case 2%-3%), and they make decisions based on this underlying belief that becomes self-reinforcing.
What did the research into expectations show?
Hunter said the findings were “good news”. Inflation expectations “appear” to be sliding back towards long-term norms and had “remained anchored” during the recent price spurt (unlike, say, in Türkiye).
And if actual inflation had lately been “sticky” (to cite previous RBA officials’ speeches), there was “no evidence of expectations being more persistent than normal”, she said.
Importantly, though, the research (by Anthony Brassil, Yahdullah Haidari, Jonathan Hambur, Gulnara Nolan and Callum Ryan) found the RBA’s model was more pessimistic about how households and unions would be about inflation than turned out to be the case.
Guardian Australia asked Hunter: if the model over-anticipated inflation expectations, does it follow official interest rates might not need to stay as high for as long?
“Inflation expectations are just one part of what determines actual inflation outcomes, of course, and broader economic outcomes as well,” and the RBA would consider “that much bigger picture”. No cigar then.
(Markets are rating only a 60% chance of an RBA interest rate cut by February, as of yesterday.)
Some price rises have more impact than others
Consumers (and businesses) form views about where inflation is headed based on a range of “salient” items that are taken as proxies for what’s happening more broadly.
Groceries and rent are obvious ones but energy prices, particularly motor fuel, tend to carry more sway than others. (Blame those red neon price signs at servos perhaps.)
And yet drivers seem to discern that price spikes from “shocks” (think Ukraine) may only be temporary. It needs “an extended period” of unusually high (or low) fuel prices before there’s “a meaningful impact on expectations”, the model suggests.
For instance, fuel price inflation was 61% between the start of 2021 and mid-2022 before dropping back to “around” historical averages. “Salient” fuel prices did not bounce around like actual bowser bills did, it seems.
We asked if that meant the RBA might “look through” another oil price spike (eg should Israel attack Iran’s oil industry) since consumers’ views take some budging.
“It’s helpful in terms of knowing that inflation expectations hopefully would stay anchored through a future period like that,” Hunter said, adding the “context” mattered. There are no “hard and fast” rules.
Is ‘rational inattentiveness’ really rational?
Among other findings: most households are slower to adjust their anticipation of future inflation based on “lived experience” compared with unions.
Inflation has to be “persistently higher or lower than previously expected for expectations to change significantly”, Hunter said.
The outcome is consistent with a so-called “rational inattention” hypothesis. The longish period when inflation was low and stable meant people didn’t think it was worth worrying too much about inflation, so they didn’t.
However, the recent experience may have shaken some of that complacency. Might that lead to “irrational attention”?
(We can think of one example: electricity prices. These make up about half of petrol/diesel’s share of the CPI basket but attract far more media notice.)
And, as a concept, can we put much store in experiences as a guide to the future?
Few of us can envisage future extreme weather that physics tells us to anticipate as global heating intensifies, but that doesn’t mean under-preparation is rational. Inflation expectations might also be among the least of our worries at some point.
Peter Hannam is Guardian Australia’s economics correspondent
