FRBSL — How Accurate Are Measures of Inflation Expectations?

Modern theories posit that actual inflation depends importantly on expected inflation. But how accurate are measures of expected inflation? A recent Economic Synopses essay examined the accuracy of measures of long-term inflation expectations....

In his essay, Kliesen looked at a survey-based measure of expected inflation and a market-based measure:

• Survey-based: A monthly survey conducted by the University of Michigan Survey Research Center that asks consumers their expectations for consumer price index (CPI) inflation over the next five to 10 years
• Market-based: Also called the breakeven inflation rate, the difference between the nominal yield on U.S. Treasury securities and inflation-indexed Treasury securities of a comparable maturity....

Kliesen found that households routinely overestimated inflation and also assumed higher expected inflation than financial markets did for the entire period studied. The mean of the survey-based measure was 49 basis points higher than the market-based measure and more than 100 basis points higher than the actual rate of inflation.

Kliesen also showed the root mean squared error (a commonly used statistic to gauge the accuracy of forecasts) for each measure of inflation expectations. He found that the market-based measure was 34 percent more accurate than the survey-based measure.

FRBSL — On the Economy
How Accurate Are Measures of Inflation Expectations?