Inflation is far above central banks’ inflation targets in most countries. Some commentators are worried that it will remain much higher than the 2% average observed in many advanced economies since 2000. As evidence, they often note that measures of expected long-run inflation have risen above the levels of a few years ago.
For instance, the Michigan survey of inflation expectations shows that expected inflation over the next year rose from 2.5% in December 2020 to 5.4% in March 2022 as CPI inflation rose from 1.3% to 8.6%.1 In the same period expected inflation over the coming 5 years rose from 2.5% to 3%, seemingly suggesting that on average future inflation would be 0.5% higher.
It should be noted that while the Michigan Survey presents the results as “expected change in prices during the next 5 years,” the question asked is in fact “about the outlook for prices over the next 5 to 10 years.” Thus, the forecast horizon is in fact uncertain. The results below are therefore calculated for both 5- and 10-year horizons.
Care is needed when interpreting the expected five-year inflation rate. To see this, consider Figure 1 below. The blue line shows that 1-year inflation expectations of 5.4% imply that prices are expected to rise from 100 to 105.4 over the next year. The orange line shows that since 5-year inflation expectations are 3%, over the next 5 years the price level is expected to rise to 115.2 Importantly, the slope of the blue line depends on 1-year inflation expectations and the slope of the orange line depends on 5-year inflation expectations.