The Federal Reserve's worst-case scenario is unfolding in real time. After nearly achieving its 2% inflation target just a year ago, the central bank now confronts something far more dangerous than high prices: consumers who no longer believe inflation will come down.
The University of Michigan's latest consumer sentiment survey shows long-run inflation expectations jumped to 3.9% in May, up from 3.5% in April and well above the 2.8%-3.2% range that held throughout 2024. Year-ahead expectations rose to 4.8%, exceeding even the 3.4% reading from February before the Iran conflict escalated.
This is what economists call "unanchored expectations"—the point where consumers assume high inflation is the new normal and adjust their behavior accordingly. They demand higher wages. They accelerate purchases before prices rise further. They lose faith in the Fed's ability to control prices. It becomes a self-fulfilling prophecy.
Chris Waller, a Federal Reserve Governor, laid out the danger in a speech in Germany last week: "If people do not know the true inflation generating process and see a sequence of positive price shocks, they may infer that the next price shock is more likely to be positive than negative."
Translation: Once consumers stop trusting the Fed's 2% target, every price increase reinforces their pessimism. The central bank loses credibility, and with it, the ability to control inflation without causing severe economic pain.
The political dimension adds another layer of complexity. Even Donald Trump's supporters—who helped return him to the White House partly on promises to bring down prices—now doubt relief is coming. Republicans' long-term inflation expectations more than doubled since February 2025, according to the Michigan survey.
Consumer sentiment has fallen below levels seen during the 1970s oil crises, dropping to record lows for three consecutive months. Joanne Hsu of the notes that
