If the Central Bank's policy is consistent, then there is hope that the population's inflation expectations will eventually be anchored where the regulator needs them.

Last week, Elvira Nabiullina, the Chairperson of the Bank of Russia, in an interview with the Rossiya 1 TV channel, drew attention to a very curious phenomenon. She noted that, despite the low actual inflation (around 2.5% at the end of 2017), the country's residents think that food prices are rising sharply. This is explained by the fact that the image of inflation that was two years ago has stuck in our memory.

This phenomenon is called anchoring of inflation expectations. Temporary changes in the economy, such as falling oil prices or high interest rates, are not reflected in the inflation rate that people expect over a relatively longer time horizon. The population seems to think that it understands well how the economy functions and what the rate of price growth should be to guarantee its stability. Therefore, for them, new data on the state of the economy and the actions of the Central Bank are just some noise that can be ignored. Long-term inflation expectations are “anchored,” stuck to some value. Inflation itself becomes more stable to changes in the level of aggregate demand: the government has an additional opportunity to experiment with the structure of the economy. In this case, economists say that the so-called Phillips curve, which shows the statistical relationship between inflation and the unemployment rate, becomes flatter.

It is good if inflation is anchored at a value that is close to the target set by the Central Bank. Then both the Central Bank and the residents are confident in the same thing and live in the same house. In addition to ensuring the stability of the ruble, the Central Bank can focus more fully on policies favorable to economic growth, for example, significantly lower the interest rate. If the anchor value of inflation expectations by the population and the Central Bank's target differ significantly (as in Russia), then the Central Bank's attempt to influence economic growth will be akin to parents trying to raise children living in another city every day. You can try, but it is unlikely to work.

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Where and how inflation expectations are anchored is currently one of the hottest areas of scientific research. Scientists do not yet have a complete understanding. On the one hand, various probabilistic anchoring measures are proposed based on popular methods for extracting inflation expectations (surveys, reverse engineering of prices of some financial instruments). On the other hand, alternative methods for working with expectations are emerging: in one of my columns in 2016, I already wrote about the research of the French financier Eric Bartalon, according to which how we form expectations of the future depends on memories of past experience and the intensity of signals about the current state of the economy.

One way or another, anchoring also depends on the actions of the Central Bank: if its policy is consistent, then there is hope that the inflation expectations of the population will eventually be anchored where the regulator needs it. Let's see what the Chairman of the Central Bank will tell us in a year.

Where inflation will drop anchor