The De-Anchoring That Didn’t Happen
Until very recently, there was lots of talk on Wall Street and among Federal Reserve officials of the danger of inflation expectations becoming “unanchored” due to tariff-induced price increases. In October, the Federal Reserve Bank of Boston published a paper warning that household inflation expectations had surged in ways that were “largely unexplained” by actual price movements, suggesting a dangerous similarity to the late 1970s when expectations became persistently elevated and fueled an inflationary spiral.
The fear was grounded in well-established economic theory. According to the dominant theory of inflation at the Fed and inside economic academia, inflation expectations matter because they shape actual inflation. The idea is that when workers expect prices to rise sharply, they demand higher wages to maintain their purchasing power. Similarly, when businesses anticipate higher labor and input costs, they raise prices preemptively. This creates a self-fulfilling cycle where expectations of inflation generate the very inflation that was feared. Federal Reserve Chair Jerome Powell has repeatedly emphasized that keeping expectations “anchored” around the Fed’s two percent target is essential to maintaining price stability.
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Do Inflation Expectations Really Matter That Much?
There are reasons to doubt that inflation expectations play as large a role in generating inflation as the consensus among economists holds. In a provocative 2021 Federal Reserve staff paper, economist Jeremy Rudd argues that the widespread belief that inflation expectations drive actual inflation rests on “extremely shaky foundations.“ Rudd systematically dismantled the theoretical justifications for the idea, showing that each model used to support it either makes ad hoc assumptions, produces predictions wildly at odds with the data, or relies on implausibly contrived mechanisms.
He notes that what little empirical evidence exists is mostly circumstantial: the correlation between long-run expected inflation and inflation’s trend could just as easily reflect households making reasonable forecasts rather than expectations causing inflation. Rudd proposes an alternative explanation where inflation dynamics depend on whether actual price changes are salient enough to affect wage bargaining—at low inflation rates (around two percent), workers simply don’t factor inflation into employment decisions because it’s not on their “radar screens,” whereas at higher rates (above 3-4 percent), inflation becomes a concern that enters wage negotiations. This matters because if expectations don’t actually drive inflation, central banks’ obsession with “anchoring expectations” through communications and policy may be misguided, and attempts to engineer higher inflation by targeting expectations could backfire by making people pay more attention to prices.
The theory is also vulnerable to the criticism that it gets the relationship between inflation and wage demands backwards. History suggests that workers do not demand higher wages because they expect more inflation in the future but because they’ve experienced high inflation already. They demand higher wages to make up for the loss of purchasing power that was inflicted by earlier inflation. That certainly seems to describe what happened in the last bout of high inflation, which saw prices skyrocket ahead of wages and wages only slowly and fitfully rise to catch-up. If that’s right, it is inflation experience and not inflation expectations that matters.
Back to the 1970s?
But that might not matter in terms of monetary policy. If the Fed believes inflation expectations matter, it will likely act on that belief. That means that if it fears expectations are becoming unanchored, it will keep monetary policy tight to ward off a rise in inflation. Alternatively, it the central bank is assured that inflation expectations remain anchored, it will be more comfortable easing policy by cutting rates even if inflation is still above target.
The Boston Fed researchers examined the University of Michigan Survey of Consumers, which showed one-year-ahead inflation expectations spiking above eight percent in March 2025. Using a regression model that tracked how households typically respond to salient price changes—particularly gas and food prices—along with broader core inflation, they found this surge alarming. In previous episodes, including the 2021-2022 pandemic inflation surge, rising prices could explain most of the increase in expectations. But in spring 2025, expectations jumped far beyond what price movements alone would predict.
The paper drew an ominous parallel to the late 1970s. In 1973-1975, about two-thirds of the surge in inflation expectations could be explained by actual price increases. But in 1978-1980, as expectations became de-anchored, only about half could be explained by prices—the rest represented a dangerous shift in psychology. The March 2025 surge looked more like 1978-1980, with less than one-eighth of the increase explained by price movements.
This reinforced concerns that had been building on Wall Street and at the Federal Reserve. The worry was that tariff announcements in early 2025 had triggered not just a temporary price shock but a fundamental shift in how Americans thought about inflation. If households expected persistently higher inflation, the Fed might need to maintain restrictive monetary policy for far longer than markets anticipated, potentially risking recession to bring expectations back under control.
But more recent data tells a different story. The danger, if it ever truly existed, appears to have passed.
Inflation Expectations Have Made a ‘Soft Landing’
The Michigan Survey shows one-year-ahead expectations peaked at 6.6 percent in May but have since fallen to 4.1 percent by December, a decline of 2.5 percentage points, or 38 percent from the peak. More importantly, five-year-ahead expectations, which better capture whether expectations are truly anchored, peaked at just 4.4 percent in April and returned to 3.2 percent by December, essentially matching the December 2024 baseline of 3.0 percent.
The New York Fed’s Survey of Consumer Expectations tells an even calmer story. Three-year-ahead expectations rose modestly from 3.0 percent in December 2024 to a peak of 3.2 percent in April 2025, then returned to 3.0 percent in November 2025. Longer-term expectations barely budged throughout the entire episode.
This pattern looks nothing like 1970s de-anchoring, when expectations rose and stayed elevated for years. In 2025, expectations ticked up briefly when tariff uncertainty peaked, then returned to baseline within months. The spike was temporary, not the sustained shift that worried the Boston Fed.
The return to normal is particularly notable because tariffs remain in place. If tariffs were going to fundamentally alter how Americans think about inflation, it clearly hasn’t happened. Households treated whatever price increases tariffs may have induced as a one-time adjustment and a shift in relative prices rather than the start of an inflationary spiral. No doubt, this was helped along by the fact that even in categories of goods where tariffs arguably did push up prices, the increase was far smaller than many analysts had predicted and was offset by price declines elsewhere in the economy.
Supporting this view, PCE data through September shows durable goods prices—the category most affected by tariffs—have fallen for three consecutive months. Far from triggering runaway inflation, the tariffs have been absorbed without generating second-round effects.
In short, the spring 2025 alarm was overstated. Expectations did what they should do in response to a temporary shock: they rose briefly, then returned to normal.
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