other hand, the public reacts to a short period of higher - than - expected inflation by marking up its long - run expectation considerably, then expectations are poorly - anchored. price rises reduce the real purchasing power of individuals. thus, if inflation is expected to be persistently high, workers bargain for higher nominal wages to protect their real income. this creates a pressure on firms ’ costs and they may in turn increase prices to maintain their profits. independently, the producers ’ own inflation expectations also affect inflation directly by influencing their pricing behaviour. if companies expect general inflation to be higher in the future, they may believe that they can increase their prices without suffering a drop in demand for their output3. in economic models with rational expectations, the inflation expectations, and hence inflation itself, is an equilibrium outcome, strongly influenced by the public ’ s beliefs about the policy rule followed by the central bank. following this insight from the rational expectations tenet, central banks increasingly communicate their policy reaction function in terms of possible paths for inflation expectations and by establishing inflation targets, attempting to anchor the public ’ s long - run inflation expectations. since uncertainty about future inflation affects households ’ purchase decision, price stability is described as an environment where economic agents need not take into account uncertainty about future inflation in their decision - making4. bernanke, b. s. ( 2007 ) ; “ inflation expectations and inflation forecasting ”, speech delivered at the monetary economics workshop of the national bureau of economic research summer institute, cambridge, massachusetts, july 10, 2007. driver, r. ( 2007 ). “ public attitudes to inflation and interest rates ”, quarterly bulletin q2, bank of england ( pp 208 – 223 ). greenspan, a. ( 1996 ), ‘ opening remarks ’, in achieving price stability, federal reserve bank of kansas city, kansas, pp. 1 – 5. bis central bankers ’ speeches empirical work from advanced countries suggests that, “ successful maintenance of price stability requires keeping long - run inflation expectations at the desired level, as economic shocks and policy mistakes come and go ”. 5 underscoring the importance of inflation expectations, the reserve bank ’ s second quarter review of monetary policy 2012 – 13 released on 30th october 2012 noted : “ a central premise of monetary policy is that low and stable inflation and well - anchored inflation expectations contribute to a conducive investment climate and consumer confidence, which is key to sustained growth on a higher trajectory in the medium - term. ” measurement of expectations while it

is challenging to conceptualise inflation expectations, it is even more difficult to measure it as it cannot be observed in real time. in order to achieve their mandate for low and stable inflation, central banks use several methods to measure the prevailing level of inflation expectations. for this, they seek to gain knowledge about the public ’ s expectations about inflation in addition to the financial market based measures. the measures used by central banks can thus be broadly classified as market - based measures and survey - based measures. let me now turn to some of the measurement issues. first, inflation - indexed bond is a market based measure of inflation expectations. it provides protection against inflation. while a conventional bond pays its coupon on a fixed principal amount, the inflation linked bonds provide coupon on inflation - adjusted principal amount. in the recent years, sovereign inflation - indexed bonds have become available in a number of countries and have provided a new instrument for use in retirement saving. the differential yields between ordinary and inflation - indexed government bonds of similar maturity provide an indication of inflation expectations. second, inflation expectations can also be derived from the yield curve of ordinary bonds of different maturities. the expectations theory implies that the shape of the yield curve depends on the expected pattern of short - term interest rates. the long - term interest rates exceed current short - term rates if short - term rates are expected to rise. the yield curve thus slopes upward. in contrast, long - term interest rates are less than current short - term rates if short - term interest rates are expected to fall. in this case, the yield curve slopes downward. the yield curves can thus be used to gauge inflation expectations. third, the survey - based approach is the other method of measuring inflation expectations. surveys can gauge people ’ s expectations for inflation by simply asking them what they expect. the survey - based methods of measuring inflation expectations are important to policy makers and researchers because they provide data on an otherwise unobservable variable. the surveys cover different target groups ─ usually they pertain to households or professional forecasters. most of these surveys present both short - term and long - term forecasts on inflation. fourth, many of the households ’ savings and expenditure decisions such as purchasing perishable and durable goods can be affected by expectations and uncertainty about future inflation. many countries, therefore, conduct consumer surveys to gauge consumer confidence including inflation expectations. in such surveys different sampling techniques such as pure panels and repeat panels are used. fifth, the survey of professional forecasters (