Inflation Expectations and Rationality: Evidence from Indonesian Survey Data

The issue of inflation expectations has continued to catch the attention of many economic researchers in recent years, due to the mere fact that the public and economic agents’ perceptions about the perceived direction of inflation can significantly influence the inflation rate itself. In an attempt to monitor inflation expectations and conduct inflation forecasting exercises, a variety of business and consumer surveys have been conducted in many countries, where agents are asked questions regarding expected price development. In this study, we measure and analyse the inflation expectations based on household survey data provided by Bank Indonesia. The paper has the following objectives: (i) to investigate the characteristics of inflation expectations in Indonesia through measuring the long-run equilibrium relationships between survey data of inflation expectations and actual inflation; and (ii) to identify whether the public expectations of inflation could be a good predictor of future actual inflation. The estimations results provide evidence that both expected and actual inflation have a long-run equilibrium. Further, while examining the causal relationship between inflation expectations and actual inflation, we firstly find strong evidence for unidirectional causality from expectations to the actual inflation. This means that the inflation expectation tends to be forward-looking; thus this can be a good predictor for future inflation in Indonesia. Secondly, other evidence indicates that the relationship between the survey data and core inflation has been relatively stronger for all the periods studied. From this, it can be inferred that despite there being various questions on the reliability of the survey data, Bank Indonesia should not be constrained in utilizing the expectations survey data for its policy decision-making together with other important economic variables.