Leaning Against Inflation Experiences

A large share of secular variation in real interest rates can be understood as the effect of monetary policy leaning against experience-based long-run inflation expectations. Survey microdata show that adaptive learning from experienced inflation generates highly persistent, slow-moving long-run inflation expectations. When expectations are shaped by experience, central banks cannot anchor them through communication. Instead, when expectations deviate from the inflation target, monetary policy must remain persistently hawkish or dovish to generate realized inflation outcomes that, through agents’ belief updating, gradually pull long-run expectations back toward the target. Consistent with this mechanism, I find a strong positive relationship between experience-based long-run inflation expectations and real interest rates in the U.S., Germany, the U.K., and Japan. Under their subjective expectations, private-sector agents do not anticipate future reversals in inflation and short-term real interest rates. As a result, long-term real interest rates move with experience-based long-run inflation expectations about as much as short-term real interest rates do, consistent with the data. Secular movements in real rates are also accompanied by persistent patterns in interest-rate forecast errors. Overall, the interaction of monetary policy and learning from experience generates a distinct source of secular real-rate variation, beyond movements in the natural rate of interest.