What role do expectations play in shaping inflation?

Expectations play a crucial role in shaping inflation primarily through their influence on consumer behavior and wage-setting. When individuals and businesses anticipate future inflation, they adjust their actions accordingly. For instance, if consumers expect prices to rise, they may choose to purchase goods sooner rather than later, increasing current demand and thereby contributing to inflationary pressure.

Similarly, if workers expect higher inflation, they may demand higher wages to maintain their purchasing power. Employers, anticipating these wage demands, might raise prices to balance the increased labor costs. This interplay between inflation expectations and wage-setting can create a feedback loop that further drives inflation.

In contrast, the other choices do not capture the comprehensive impact of expectations on inflation. Expectations are not irrelevant; they significantly shape economic behaviors and outcomes. They are also not limited to only affecting prices in fixed contracts, as inflation expectations can cause broader changes in market dynamics. Lastly, while they might influence perceptions of the money supply, they do not directly regulate it, as monetary policy tools ultimately govern the money supply in the economy.