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January 17, 2018 

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INFLATIONARY EXPECTATIONS, AGGREGATE DEMAND DETERMINANT:

One of several specific aggregate demand determinants assumed constant when the aggregate demand curve is constructed, and that shifts the aggregate demand curve when it changes. An increase in the inflationary expectations causes an increase (rightward shift) of the aggregate curve. A decrease in the inflationary expectations causes a decrease (leftward shift) of the aggregate curve. Other notable aggregate demand determinants include interest rates, federal deficit, and the money supply.
Inflationary expectations are the expectations that consumers have concerning future inflation. Inflationary expectations work for aggregate demand much like buyers' expectations work for market demand. Buyers seek to purchase a good at the lowest possible price.
  • If buyers expect higher prices in the future, then they increase their demand in the present.

  • If buyers expect lower prices in the future, then they decrease their demand in the present.
The relation that exists between price expectations and market demand also applies to inflationary expectations and aggregate demand.
  • If consumers expect higher inflation in the future, then they increase consumption expenditures in the present.

  • If consumers expect lower inflation in the future, then they decrease consumption expenditures in the present.
In each case, households seek to buy goods at the lowest possible prices.

A change in the inflationary expectations, by changing consumption expenditures, induces changes in aggregate demand. Expectations of higher inflation increases aggregate demand and expectations of lower inflation decreases aggregate demand.

Shifting the Curve
Shifting the Curve

Consider a regular, run-of-the-mill aggregate demand curve such as the one displayed here. Like all aggregate demand curves, this one is constructed based on several ceteris paribus aggregate demand determinants, such as inflationary expectations. The key question is: What happens to the aggregate demand curve if inflationary expectations change?

Expecting Higher Inflation

Suppose, for example, that the inflation rate has been running at a nice constant 2 percent for several years. Households have been able to include this 2 percent inflation rate into their assorted plans (attaining loans, negotiating wage increases, buying cars and houses). They count on 2 percent inflation. Now suppose that irresponsible monetary policy causes an increase in the inflation to 3 percent one year, then to 4 percent the next, the 5 percent the following year, each time catching the household sector, which had been expecting only 2 percent inflation, off guard.

The household sector is bound to adjust. Rather than expecting 2 percent inflation, they adjust their expectations upward, perhaps to 5 percent, 6 percent, or even higher. As part of their adjustment, they decide to increase their consumption expenditures, especially for expensive durable goods, rather than waiting. If the price of a house is expected to be higher next year, they decide not to wait, but to buy now. The increase in inflationary expectations causes an increase in consumption expenditures and subsequently an increase aggregate demand.

To see how a higher inflationary expectations affects the aggregate demand curve, click the [Higher Expectations] button. The increase in inflationary expectations cause an increase in aggregate demand, which is a rightward shift of the aggregate demand curve.

Expecting Lower Inflation

Expectations can, of course, work both ways. Suppose that after years of 5 percent inflation, the inflation rate is brought down to 4 percent, then 3 percent, then 2 percent. While the downward adjustment of inflation expectations might take longer, the household sector is bound to adjust, eventually. When it does, the household sector is likely to postpone current consumption expenditures, awaiting lower inflation rates expected in the future. The decrease in inflationary expectations causes a decrease in consumption expenditures and subsequently a decrease aggregate demand.

To see how lower inflationary expectations affects the aggregate demand curve, click the [Lower Expectations] button. The decrease in inflationary expectations cause a decrease in aggregate demand, which is a leftward shift of the aggregate demand curve.

What Does It Mean?

The importance of the inflationary expectations as an aggregate demand determinant was revealed by high and rising inflation rates during the 1970s. Inflation rates continued to rise during this period in spite of contractionary fiscal policies in large part because the public "expected" inflation to rise. Once this relation was uncovered, manipulation of inflationary expectations was used during the 1980s, especially during the contraction of the early 1980s, to reduce inflation and to keep it low throughout the 1990s.

Inflationary Expectations and the Price Level

Do not to confuse changes in inflationary expectations with changes in the price level. Changes in the price level cause a change in aggregate expenditures and a movement along the aggregate demand curve. Inflationary expectations, in comparison, cause a change in aggregate demand and a shift of the aggregate demand curve. These are separate, distinct relations.

They are, however, not totally independent. An increase in the price level, and thus a higher inflation rate could, I repeat COULD, trigger an increase in inflationary expectations. If this happens, then aggregate expenditures would decrease (a movement on the aggregate demand curve), the result of an increase in the price level. And the increase in inflationary expectations would cause an increase in aggregate demand (a shift of the aggregate demand curve). However, it is also possible that inflationary expectations DO NOT increase. They could even decrease. This is why it is always best to analyze each change separately.

<= INFLATION RATEINFLATIONARY EXPECTATIONS, AGGREGATE EXPENDITURES DETERMINANT =>


Recommended Citation:

INFLATIONARY EXPECTATIONS, AGGREGATE DEMAND DETERMINANT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: January 17, 2018].


Check Out These Related Terms...

     | aggregate demand determinants | interest rates, aggregate demand determinant | federal deficit, aggregate demand determinant | money supply, aggregate demand determinant | consumer confidence, aggregate demand determinant | exchange rates, aggregate demand determinant | physical wealth, aggregate demand determinant | financial wealth, aggregate demand determinant | change in aggregate demand | change in aggregate expenditures | aggregate demand shifts | slope, aggregate demand curve | aggregate supply determinants |


Or For A Little Background...

     | aggregate demand | aggregate expenditures | aggregate demand and market demand | determinants | gross domestic product | consumption expenditures | investment expenditures | government purchases | net exports | price level | real production | GDP price deflator | real gross domestic product | inflation | inflation rate |


And For Further Study...

     | AS-AD analysis | aggregate market | business cycles | circular flow | Keynesian economics | monetary economics | aggregate market shocks | buyers' expectations, demand determinant | inflationary gap |


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