In November 2023, the United States saw prices rise by 3.1% compared to October 2022, while the Eurozone experienced a 2.4% increase. The Federal Reserve, in its December 13th meeting, decided to maintain interest rates between 5.25% and 5.5%, with plans for a gradual reduction of 75 basis points in 2024. This move aims for a “soft landing” strategy to control inflation without causing a recession, amidst signs of economic slowdown. Similarly, the European Central Bank (ECB) decided to keep interest rates unchanged at 4.5% to 4.75%, with deposit rates at 4.0%.
The International Monetary Fund’s (IMF) October review highlighted the role of inflation expectations and their connection to monetary policy. While central banks’ restrictive measures have started to yield results, forecasts indicate further inflation reduction in 2024. However, core inflation, excluding food and energy, remains persistent, with expectations suggesting it may not reach target levels until 2026. Heightened inflation fears have deeply influenced economic agents’ expectations, significantly impacting their decisions on investment, consumption, and financial measures.
Understanding Inflation Expectations: Inflation psychology drives expectations, with economic agents anticipating future price increases based on current trends. Businesses preemptively raise prices, workers demand higher wages, and consumers accelerate spending, fueling an inflationary spiral. Central banks aim to stabilize expectations by setting inflation targets and convincing agents that they will be met. When firms and households trust the central bank’s ability to control inflation, it anchors expectations, facilitating policy implementation. However, unanchored expectations complicate monetary policy effectiveness, prolonging inflationary periods.
Past Experiences and Expectations: Previous episodes reveal the significance of inflation expectations in shaping economic behavior. Short-term expectations fluctuate but exhibit consistency, influencing inflation trends. The IMF’s analysis identifies a strong statistical relationship between inflation expectations and actual inflation, particularly in the short term. The proportion of “backward-looking participants” in the population affects policy effectiveness, with trust in central bank communication crucial for anchoring expectations.
Influencing Inflation Expectations: Clear and transparent communication from central banks enhances trust, encouraging forward-looking behavior among economic agents. Building trust takes time, complementing concrete policy measures like monetary tightening. While monetary policy primarily targets money supply and interest rates, the financial sector’s role in inflation remains significant, especially in emerging economies. Foreign exchange dynamics and banking sector practices influence inflation expectations and monetary policy effectiveness.
Financial Sector Dynamics: Commercial banks’ practices, such as adjusting interest rates on loans and deposits, impact inflation dynamics. In 2023, banks in Serbia maintained high lending rates while offering low savings rates, stimulating investment and consumption but contributing to inflationary pressures. Bank profits surged in 2023, reflecting the sector’s robust performance amid inflation concerns. However, reliance on inflation-driven profits poses risks, necessitating vigilant oversight from monetary and fiscal authorities.
In conclusion, managing inflation requires a multifaceted approach that addresses both economic fundamentals and expectations. Clear communication, prudent monetary policy, and oversight of financial sector practices are essential for anchoring inflation expectations and achieving long-term price stability.
