Inflationary expectations are believed to cause general price increases, such as when oil prices rise sharply. The state of inflation expectations greatly influences actual inflation and the central bank’s ability to achieve price stability. Central bank policies are believed to stabilize inflationary expectations, preventing shocks to price momentum and making them less sensitive to economic data changes.
Anchoring inflation expectations is vital in eradicating inflation, as it ensures that sudden large price increases for some goods are unlikely to lead to general price increases. To track underlying price increases, central bank policy makers must be clear about their monetary policy and target rate of inflation. To make inflation expectations well anchored, central bank policy makers must be clear about their monetary policy and target rate of inflation. However, the emergence of inflation in response to oil price increases requires increases in expected inflation. Bernanke states that a one-off change in energy prices can translate into persistent inflation only if it leads to higher expected inflation and a consequent ‘wage-price spiral.’
The article argues that inflation is not caused by increases in the money supply, but rather by the rise in inflationary expectations. The price of a good is the monetary amount paid per unit of a good, and if the money stock remains unchanged, the number of dollars spent per unit of a good will also remain unchanged. If individuals increase their inflationary expectations due to a strong increase in oil prices, the money stock will remain unchanged, preventing a general increase in the prices of goods and services.
Instead, more money will be spent on oil and energy-related products, leading to higher prices for these goods and services. The article also argues that inflation’s real harm comes from the damage it inflicts upon the wealth-generation process, as it sets in motion exchanges of nothing for something, diverting wealth from wealth generators to non-wealth generators.
Milton Friedman, an economist, argues that inflation, if expected by producers and consumers, produces minimal damage. However, unexpected inflation leads to resource misallocation and weakens the economy. Friedman believes that expected inflation, or expected general price increases, are relatively harmless. He believes that the negative side effects are caused by price increases themselves, not the money supply. He believes that a fixed growth rate for the money supply can stabilize price increases and promote economic growth. However, this does not change the fact that the money supply continues to expand, leading to resource diversion from wealth producers to non-wealth producers. Therefore, stabilizing prices can generate more instability through resource misallocation.