What Does the Concept of "Expectation" Mean in Economics?

What does the concept of "expectation" mean in economics? How does economic expectation affect pricing? In this article, we've covered the Investing.com analysis.

Near the end of 2020, the change of the CBRT Chairman in November brought a change in monetary policy. Since the appointment of Naci Ağbal as the head of the CBRT in the place of Murat Uysal, monetary policy has been tightened in order to stop the rise of both the exchange rate, inflation and current account deficit and to bring the indicators to the target levels. At the first Monetary Policy Committee (MPC) meeting in 2021, the CBRT stated, "Considering the 2021 year-end forecast target, it has decided to continue the tight monetary policy stance for a long time until strong indicators are formed that point to a permanent decline in inflation and price stability." This clearly signaled that the tight monetary policy will continue. In the inflation report presentation following the MPC meeting, CBRT Chairman Ağbal's prominent lines were as follows:

• The 2021 year-end inflation target was preserved at the previously determined 9.4%.
• It is too early to talk about a interest rate reduction in 2021.
• We will use all tools to achieve price stability and if there is a risk of deviation from the target, additional tightening will be made beforehand if necessary.
• In order to achieve the targets, it is imperative that the monetary policy act jointly with all actors in the economy.
• The government is with us, giving the necessary support.
• Inflation will stay high for few more months.

These lines created the perception that the rise in inflation will continue for a while. In addition, the Central Bank did not change its target of a single digit inflation rate at the end of the year. In order to achieve this, the bank will ensure the effective use of all the tools it says. While it seems like a more or less consensus has been reached on the anti-interest rate of the political authorities, thoughts suggest that there may be another rate hike depending on the rate of increase in inflation. However, despite the said increase, the tight and determined stance of the CBRT created an important "expectation" in the markets.   So what is "expectation" in the economy? How does expectation affect pricing? Expectation refers to the idea that important indicators in a country's economy should be shaped according to their previous state and will continue accordingly. However, with important developments and changes, the expectation may reveal the opposite of the current situation. Although this is an unavoidable possibility, expectation often draws on past experiences. To explain this with concrete examples; We know that for many years the inflation rate remains high in Turkey. Although there are periodic decreases, when the past is analyzed, it is possible to see that inflation has never been at the desired level. Consequently, our expectation for inflation is generally high. We anticipate that even with occasional decreases, inflation will continue to rise. This thought is a result of past experiences. In a country with a low inflation rate, the situation is the opposite of what happened in Turkey. For example, even if there were increases in the inflation rate in Japan or the USA, there was no expectation that this would continue. The reason for this is that inflation is always low in these countries. Inflation rate shapes our interest rate expectations. In a country with high inflation, there cannot be a very low interest rate. What is meant here is that the interest rate is not just below the inflation level, but rather below the inflation level. It is the second situation that should be feared. In fact, until the third quarter of 2020, we have personally seen the increase in demand for foreign exchange rates due to the fact that the interest rate is below the inflation rate in Turkey.   How Does Expectation Affect Pricing? Increasing inflation brings along an expectation that interest rates will also rise. The same is true for a decrease. If inflation begins to fall and continues to fall, not limited to short periods such as 1-2 months, there is an expectation that the interest will also decrease. Many situations that take place on the foreign exchange front are often a result, not a cause. If the local currency's yield lags behind inflation, the demand for foreign currency increases. The point to be considered here; Except for inflation and interest, there is an increase in exchange rates, in this case the increase in exchange rate also leads to inflation. In Turkey, every change in the interest-inflation and exchange rate cycle continues to affect each other in recent years. Accordingly, the expectation of an increase also affects pricing. 2021 will be a year when CBRT policies will be closely monitored. Therefore, the CBRT primarily creates expectations in order to give confidence while implementing these policies. At this point, the CBRT clearly announces the risks and also announces the measures to be taken with its transparent behavior. These steps of the Central Bank have changed the market expectations positively compared to 2020. We are witnessing that the expectations change as a result of the changes and developments implemented by the policies implemented by the bank. However, it is worth mentioning at this point: the main challenge is to keep the current situation after turning the situation into a positive one. In this sense, policies must be preserved as they are.     Source: Investing.com