The Bank of England's Quarterly Bulletin, answering the critical question for an inflation-targeting central bank: How are households' inflation expectations formed?
People’s expectations about future inflation are an important influence on the current rate of inflation: when people believe that inflation will be at target in the medium term they set wages and prices in a way that is consistent with those beliefs.
The study was conducted just on the UK economy, but its conclusions have wider relevance.
Not surprisingly, one of the primary drivers of inflation expectations are recent changes in prices in shops. Still, it is good to see that the level of an inflation target does indeed play a role over the longer run.
Households’ inflation perceptions are an important influence on the inflation expectations of many households, particularly at shorter horizons. And historically, changes in inflation perceptions are estimated to be associated with a similar scale change in one year ahead inflation expectations.
The relationship between changes in CPI inflation itself and households’ inflation expectations is far less strong, and not statistically significant at longer horizons.
Households’ inflation expectations, particularly at longer horizons, are also influenced by a wider range of macroeconomic factors, including the inflation target.
Worth reading in full.