How Are Inflation Forecasts Determined?

Expected inflation is the rate of inflation predicted by people to determine the wage rate of money and the price of other currencies. Is an estimate of future actual inflation.

Expected inflation rate

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Many economic and business decisions involve expected inflation rates. In fact, almost all issues related to future cash flows involve expected inflation rates, such as calculating the real interest rate on bonds or evaluating any investment plan. Or to assess whether salary adjustments can increase purchasing power. Since the expected inflation rate is so important, how do we measure the expected inflation rate?

There are two methods to measure the expected inflation rate. The first method is to measure investors' expectations of inflation based on the market interest rate gap between the general bonds and price index linked bonds with the same maturity date. The second method is to conduct direct interviews with the general public or economic experts and ask them about their expectations for future inflation.

In the first method, governments including the United States, Canada, and Israel have issued a bond that is guaranteed to fight inflation, called TIPS, Treasury Inflation-Protected Securities, or price index Linked bonds. The principal of this kind of bond is adjusted according to the consumer price index, and the interest is calculated by multiplying the adjusted principal of the consumer price index by a fixed interest rate (determined when the bond is issued). Under this design, no matter how high the inflation rate, bondholders can get a certain real interest rate. We can get the investor's expectation of inflation based on the market interest rate gap between the traditional bonds and TIPS with the same maturity date. For example, the 5-year traditional bonds have a 10% yield to maturity and the 5-year TIPS The yield to maturity is 7%, then we can use Fisher's equation "to know that investors expect prices to rise by an average of 3% per year over the next five years. Because the maturity of government bonds is usually long (such as 5 years, 10 years), and there are various government bonds with different maturities in the financial market, we can use this method to calculate the short-term and long-term expected inflation rates. .

The institution that uses the second method to measure the expected inflation rate is the University of Michigan, which is the most famous. The University of Michigan Research Center surveys hundreds of Americans every month and asks them Inflation rates are expected over the next 12 months. In addition, the Philadelphia Branch of the Federal Reserve Bank interviewed economic experts and asked them about their expectations for inflation in the next 12 months.