Question

Why is inflation expectation so important to Fed's decision on monetary policy. Please be detailed.

Answer 1

Inflation expectation is important for the Federal Reserve decision on the monetary policy because it will be providing an idea for the Federal Reserve about the monetary flow into the economy as inflation expectation is reflecting the level of demand and supply into the economy and when there will be a higher level of inflation, it will mean that there is a higher demand in the economy,so the Federal Reserve will take all probable measures in order to reduce the monetary flow and increase interest rate.

When the interest rates are increased, it will mean that the inflation is controlled to certain extent whereas when the inflation is lower in the economy, then the Federal Reserve will be trying to stimulate the demand into the economy and increase the inflation to the expected inflation level and increased inflation will mean that there is an optimum demand and optimum level of prices in the economy so the Federal Reserve will always be trying to maintain inflation expectation in order to estimate the the monetary policy in advance because inflation is one of the important element in order to decide the monetary policy rates and approaches of the Federal government in future.