experience that high inflation imposes greater costs and fewer benefits than previously thought, then the equilibrium will adjust toward one with lower inflation and lower inflation expectations. this line of explanation of how economies move between monetary regimes, which has been explored by sargent and others, strikes me as quite plausible as a historical description ( sargent, 1999 ). in sum, many of the most interesting issues in contemporary monetary theory require an analytical framework that involves learning by private agents and possibly the central bank as well. implications of anchored inflation expectations why do we care about the variability of inflation expectations? as my colleague rick mishkin recently discussed, the extent to which inflation expectations are anchored has first - order implications for the performance of inflation and of the economy more generally ( mishkin, 2007 ). mishkin illustrated this point by considering the implications of the fact that inflation expectations have become much better anchored over the past thirty years for the estimated coefficients of the conventional phillips curve, which i define here to encompass specifications that use lagged values of inflation to proxy for expectations or other sources of inflation inertia. as he noted, many studies of the conventional phillips curve find that the sensitivity of inflation to activity indicators is lower today than in the past ( that is, the phillips curve appears to have become flatter ) ; 1 and that the long - run effect on inflation of " supply shocks, " such as changes in the price of oil, also appears to be lower than in the past ( hooker, 2002 ). these findings are of much more than academic interest. to the extent that the phillips curve may have flattened, inflation will now tend to be more stable than in the past in the face of variations in aggregate demand. ( of course, this can be a good thing or a bad thing, depending on whether inflation expectations are anchored in the vicinity of price stability. ) likewise, a lower sensitivity of long - run inflation to supply shocks would imply that such shocks are much less likely to generate economic instability today than they would have been several decades ago. notably, the sharp increases in energy prices over the past few years have not led either to persistent inflation or to a recession, in contrast ( for example ) to the u. s. experience of the 1970s. various factors might account for these changes in the phillips curve, but, as mishkin pointed out, better - anchored inflation expectations – themselves, of course, the product of monetary policies that brought inflation down and have kept it relatively stable – certainly play

some role. if people set prices and wages with reference to the rate of inflation they expect in the long run and if inflation expectations respond less than previously to variations in economic activity, then inflation itself will become relatively more insensitive to the level of activity – that is, the conventional phillips curve will be flatter. similar logic explains the finding that inflation is less responsive than it used to be to changes in oil prices and other supply shocks. certainly, increases in energy prices affect overall inflation in the short run because energy products such as gasoline are part of the consumer's basket and because energy costs loom large in the production of some goods and services. however, a one - off change in energy prices can translate into persistent inflation only if it leads to higher expected inflation and a consequent " wage - price spiral. " with inflation expectations well anchored, a one - time increase in energy prices should not lead to a permanent increase in inflation but only to a change in relative prices. a related implication is that, if inflation expectations are well anchored, changes in energy ( and food ) prices should have relatively little influence on " core " inflation, that is, inflation excluding the prices of food and energy. although inflation expectations seem much better anchored today than they were a few decades ago, they appear to remain imperfectly anchored. a number of studies confirm that observation. for example, gurkaynak, sack, and swanson ( 2005 ) found that long - run inflation expectations, as measured by the difference in yields between nominal and inflationindexed bonds, move in response to news about the economy, rather than remaining unaffected. levin, natalucci, and piger ( 2004 ) have shown that some survey measures of inflation expectations in the united states respond to recent changes in the actual rate of inflation, which would not be the case if expectations were perfectly anchored. models of the term structure of interest rates better fit the data under the assumption that both inflation roberts ( 2006 ) provides a recent overview. he attributes most of the " flattening " of the phillips curve to changes in the conduct of monetary policy. see also nason ( 2006 ). gordon ( 2007 ) provides an opposing view. expectations and beliefs about the central bank's reaction function are evolving ( kozicki and tinsley, 2001 ; rudebusch and wu, 2003 ; cogley, 2005 ). an indirect but elegant way to make the point that inflation expectations remain imperfectly anchored comes from a statistical