Inflation in the United States began to rise in early 2021 and, despite peaking in 2022, has declined more slowly than expected. The initial surge was linked to supply chain disruptions and increased demand for goods during the COVID-19 pandemic. While inflation in the goods sector fell rapidly after mid-2022, overall inflation—which also includes services—remains above the Federal Reserve’s target of 2 percent.
According to research by Bocola and others (2024), financial markets perceived that the Federal Reserve’s response to rising inflation had weakened during this period. They introduced an “inflation feedback parameter” to measure how much policymakers are expected to change interest rates when inflation deviates from target levels. Data show that between 2017 and 2019, a one percentage point increase in expected future inflation led markets to expect a 1.9 percentage point rise in nominal interest rates. In contrast, from 2020 to 2022, markets anticipated only a 1.1 percentage point increase for the same change in expected inflation. This indicates that market expectations of monetary policy became less responsive as inflation rose.
After the Federal Reserve raised the federal funds rate and maintained tighter monetary policy beginning in 2023, market perceptions shifted again toward expecting a stronger policy response.
Research by Doh and Yang (2023) suggests that when markets expect smaller adjustments in interest rates following changes in inflation, current inflation becomes more closely tied to future inflation—a pattern known as greater persistence. Their findings indicate that shifts in monetary policy alone can influence how long elevated inflation lasts, independent of whether underlying shocks are temporary or persistent.
Sargent and Williams (2025) argue: “If policymakers treat low inflation persistence as a given ‘input’ to monetary policy—rather than an outcome of the policy response—they may underestimate the persistence of inflation after a shock they believed to be temporary.” They add: “However, if this muted response to inflation is embedded in the private sector’s inflation expectations, then inflation persistence is likely to rise.” The authors conclude: “Accordingly, policymakers may need to recognize inflation persistence as an outcome of a well-calibrated monetary policy to avoid prolonging the inflationary effects of a temporary shock.”
The experience following COVID-19 highlights how perceptions about central bank actions can affect both market expectations and actual outcomes regarding price stability.
