Reserve Bank focus: Why managing inflation expectations is crucial – Mark Lister

The Reserve Bank has released two distinct surveys highlighting a significant divide in how New Zealanders perceive the future of inflation. While professional forecasters remain optimistic about long-term stability, typical households express a more cautious outlook based on their daily cost-of-living experiences.

The Divide Between Experts and Households

In mid-May, the Reserve Bank canvassed approximately 40 economists, business leaders, and professional forecasters. This group remains relatively relaxed, with five-year inflation expectations sitting around 2.2% and 10-year expectations just above 2%.

Conversely, a survey of more than 1,000 New Zealand households revealed a different perspective. The typical household expects inflation to remain around 5% a year from now and 4% in two years’ time.

Even looking five years ahead, households expect inflation to run hotter than the levels the Reserve Bank desires. This discrepancy suggests a gap between spreadsheet models and the reality of supermarket receipts and insurance bills.

The Risk of Self-Fulfilling Inflation

The Reserve Bank is focused on “anchoring” inflation expectations to prevent a self-fulfilling cycle. If enough people expect prices to rise, their subsequent behavior may ensure that they do.

This cycle typically manifests when workers push for higher pay to offset rising living costs and businesses increase prices in anticipation of higher expenses. Simultaneously, consumers may bring forward purchases of goods they expect will cost more tomorrow.

To prevent this, the bank is engaged in a strategic effort to convince consumers, businesses, and financial markets that inflation will remain low and stable in the coming years.

Potential Future Scenarios

The trajectory of inflation may depend heavily on public perception of current economic shocks. If the Reserve Bank can convince the public that the recent fuel price spike is temporary and isolated, price stability may be maintained.

However, a different scenario could emerge if households lose faith in the bank’s resolve. If perceptions of high inflation persist, the bank’s task of controlling price pressures could become significantly harder.

While rampant inflation is not a foregone conclusion, the lingering experience of the last five years—where inflation has been close to 5% per annum—may keep households braced for further shocks.

Frequently Asked Questions

What are “anchored” inflation expectations?
It refers to the Reserve Bank’s effort to convince consumers, businesses, and markets that inflation will remain low and stable in the years ahead to keep economic behavior in check.

How do expert expectations differ from household expectations?
Experts see long-term inflation (5 to 10 years) settling around 2% to 2.2%, while households expect it to be around 5% in one year and 4% in two years.

What factors have caused experts to raise short-term inflation views?
Professional forecasters have raised their short-term views due to supply chain disruptions and higher fuel prices.

Do you believe that personal experience with daily prices is a more accurate indicator of inflation than official economic forecasts?