Inflation Expectations and Monetary Policy

Measuring and assessing expected inflation play an important role as inflation expectations of firms and households over various horizons influence wage and price decisions, thereby affecting inflation in an economy. Hence, a central bank needs to take the public’s expectation of inflation into account when conducting and determining the stance of monetary policy to achieve its overriding objective of price stability. At the same time, central banks need to continuously assess the credibility of its monetary policy through inflation expectations. Hence, aligning inflation expectations of the general public with the implicit or explicit inflation target of the central bank is imperative in order to meet central bank objectives. This paper examines the significance of measuring inflation expectations for effective conduct of monetary policy focusing on various measures of expected inflation, problems in measuring expected inflation supported by empirical evidence. At the same time, it was attempted to elaborate on efforts in measuring inflation expectations by the Central Bank of Sri Lanka.