I think it is time to talk a little bit about “anchored inflation expectations.”

Key to a lot of the inflation modeling at the Fed, and in some sterile economics classrooms around the country, is the notion that inflation is partially shaped by the expectations of inflation. Therefore, when people expect inflation to remain down, it tends to remain down. Thus, you often hear Fed officials talk about the importance of inflation expectations being anchored, and that phrase appears often in Federal Reserve statements and minutes.

I have long found it interesting that with as much as the Fed relies on the notion that inflation expectations are anchored, they have no way to accurately measure inflation expectations. Former Fed Chairman Bernanke said in a speech in 2007 that three important questions remain to be addressed about inflation expectations:

According to Bernanke, the staff at the Federal Reserve struggle with even the first of these questions (“while inflation expectations doubtless are crucial determinants of observed inflation, measuring expectations and inferring just how they affect inflation are difficult tasks”), although this has not deterred them from tackling the second and third questions. Economists use the Hoey survey, the Survey of Professional Forecasters, the Livingston survey, the Michigan survey, and inflation breakevens derived from the TIPS or inflation swaps markets. But all of these suffer from the fundamental problem that what constitutes “inflation” is a difficult question in itself and answering a question about a phenomenon that is hard to quantify viscerally probably causes people to respond to surveys with an answer indicating what they expect the well-known CPI measure to show. I talked about many of these problems in my paper on measuring inflation expectations (“Real-Feel” Inflation: Quantitative Estimation of Inflation Perceptions), but the upshot is that we don’t have a good way to measure expectations.