Seemingly Anchored Inflation Expectations

Empirical evidence commonly cited as indicating that inflation expectations have become better anchored includes the declining sensitivity of expectations to inflation surprises over time, particularly around the adoption of inflation targeting. These patterns are typically attributed to the influence of explicit or implicit inflation targets on inflation expectations. We show that this evidence is consistent with a model of experience-based learning in which individuals learn solely from their life-time history of realized inflation, without anchoring their expectations to an announced inflation target. In this model, the prolonged experience of low short-run inflation persistence in the pre-COVID decades renders long-run expectations insensitive to inflation surprises, matching the patterns observed in empirical anchoring tests. A unique prediction of the experience-based learning model is also borne out in the data: the decline in surprise sensitivity since the 1980s is strongest among younger individuals. The memory of low inflation persistence experiences further explains why long-run inflation expectations remained stable in the face of the post-COVID inflation surge. At the same time, simulations indicate that the sensitivity of long-run expectations to inflation surprises would rise sharply if individuals were to experience another sustained episode of highly persistent inflation. Overall, long-run inflation expectations may be less firmly anchored than commonly believed.