Charles S. Gascon

Richard G. Anderson

English

Research Papers in Economics

September 2008 MonetaryTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
M
aintaining expectations of a low, stable inflation
rate is essential to achieving the goals of monetary
policy. But how, exactly, do households and firms
form inflation expectations? It seems reasonable that rapidly
rising prices for frequently purchased goods would attract
more notice than stable prices for goods purchased less fre-
quently.  Recent correlations between increases in gasoline
prices and in inflation expectations provide an example.
Federal Reserve Chairman Bernanke cited this risk in his
July 15 Monetary Policy Report to the Congress: “…the
currently high level of inflation, if sustained, might lead the
public to revise up its expectations for longer-term inflation.
If that were to occur, and those revised expectations were to
become embedded in the domestic wage- and price-setting
process, we could see an unwelcome rise in actual inflation
over the longer term. A critical responsibility of monetary
policy makers is to prevent that process from taking hold.”1
During 2008, through June, the U.S. all-items CPI
increased at a 5.4 percent rate, while the chain-price index
for personal consumption expenditures (PCE) increased at
a 3.3 percent pace. The comparable “core” measures that
exclude food and energy increased at 2.3 percent and 1.9
percent rates, respectively. By some measures, inflation expec-
tations increased as well. In the University of Michigan’s
household survey, the median expected inflation rate for the
next 12 months increased from 3.4 percent in the December
2007 survey to 5.1 percent in the July 2008 survey, its second-
highest level since 1981, just below May’s 5.2 percent figure.
Although the survey’s median expected inflation rate for the
next 5 to 10 years changed little, from
3.1 percent in December to 3.2 per-
cent in July, it is at its second-highest
level since 1995, just below May and
June’s 3.4 percent figures. These
increases seem incongruous with the
1.9 percent rate of increase of the
chain-price index for core PCE, the
FOMC’s preferred inflation measure.
Linkages between commodity
prices and inflation expectations also
are a concern in Europe. In the United
Kingdom, the all-items CPI increased
0.7 percent in June and is 3.8 percent
higher than one year earlier, the largest year-over-year increase
since June 1992. The core CPI, however, was up only 1.6 per-
cent year-over-year. Accord  ing to the YouGov/Citicorp survey,
inflation expected during the next 12 months jumped to 4.6
percent in June from 4.1 percent in May. Similarly, inflation
expected for the next 50 years (inferred from inflation-indexed
gilt bonds) rose to 4 percent. In the euro area, June consumer
price inflation was at a 4 percent annual rate, double the
European Central Bank’s (ECB) desired rate; on July 3, the
ECB raised its benchmark interest rate to 4.25 percent. Press
reports cited concern that inflation expectations were increasing.
Increases in gasoline prices are shown in the table. The
retail price of gasoline in the United States increased 30 percent
during the first half of 2008, while gasoline prices in the United
Kingdom and the euro area increased between 8 percent and
15 percent. The relatively higher taxes in Europe, accounting
for more than half the retail price, buffer gasoline’s retail price
against increases in the cost of crude oil.
Recent increases in inflation expectations appear to more
strongly reflect rising commodity prices, rather than core infla-
tion rates or policymakers’ longer-term inflation goals. Europe’s
lesser rate of increase in gasoline prices perhaps provides the
ECB and the Bank of England a bit more policymaking flexi-
bility. The much larger increase in the United States suggests
more difficult circumstances for the Federal Reserve.
—Richard G. Anderson and Charles S. Gascon
1 Chairman Ben S. Bernanke, Semiannual Monetary Policy Report to the
Congress, before the Committee on Banking, Housing, and Urban Affairs, U.S.
Senate, July 15, 2008.
Fueling Expected Inflation
research.stlouisfed.org
Retail Gasoline Prices
Belgium France Germany Italy Netherlands U.K. U.S.
Increase per gallon, in each country’s own currency, January 7 to July 14, 2008
10% 8% 10% 11% 9% 15% 30%
Tax component per gallon, in U.S. dollars, as of July 14, 2008
Retail price with taxes $9.40 $8.95 $9.27 $9.23 $10.16 $9.02 $4.34
Retail price without taxes $4.18 $3.83 $3.85 $4.29 $4.53 $3.87 $3.94
Tax share of retail price 55.5% 57.2% 58.5% 53.5% 55.4% 57.1% 9.2%
SOURCE: Energy Information Agency, FRB H.10, and authors’ calculations.

Fueling expected inflation

http://research.stlouisfed.org/publications/mt/20080901/cover.pdf

Fueling expected inflation

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics