By Tom Smith of the Bank’s Macro Financial Analysis Division.
Beliefs about future inflation play a major role in determining the rate of inflation, and so it is important for the Monetary Policy Committee to take them into account when making their policy decisions. A number of measures of central expectations for inflation are available, such as surveys of inflation expectations or measures derived from financial markets. But until recently far fewer measures of beliefs about the full distribution of possible future inflation rates have been available. This article describes a new method for producing option-implied probability density functions for future inflation, which can be used as a measure of that distribution, and examines the recent rise in uncertainty about future inflation that they reveal.