Low inflation can negatively impact inflation expectations under both adaptive and rational expectations frameworks.....

 Low inflation, especially when sustained, can negatively affect inflation expectations, potentially leading to a downward spiral in both inflation and expectations, especially under adaptive expectations. A neutral central bank stance, without a clear commitment to future price increases, can exacerbate this issue by failing to actively counter the negative trend. However, under rational expectations, the impact is more nuanced and depends on the credibility of the central bank's commitment to its inflation target, even if it maintains a neutral stance.

Adaptive Expectations:

Backward-looking:

Under adaptive expectations, individuals base their future inflation expectations primarily on past inflation rates.

Low inflation's impact:

If inflation has been low for a prolonged period, adaptive expectations will lead to lower future inflation expectations.

Reinforcing cycle:

This, in turn, can lead to lower actual inflation as firms and workers set prices and wages based on these lower expectations, potentially creating a self-fulfilling prophecy of low inflation and further lowering expectations.

Neutral stance problem:

A neutral central bank, without a clear commitment to future price increases, may not counteract this trend, allowing the downward spiral to continue.

Rational Expectations:

Forward-looking:

Rational expectations assume that individuals use all available information, including the central bank's policy announcements and past behavior, to form their expectations.

Credibility matters:

The impact of low inflation on expectations under rational expectations depends on the central bank's credibility. If the central bank is seen as committed to its inflation target, even a period of low inflation may not significantly alter expectations.

Neutral stance and credibility:

However, if the central bank's neutral stance is interpreted as a lack of commitment to its inflation target, or if the central bank has a history of failing to meet its targets, then rational expectations may also lead to lower future inflation expectations.

Potential for stabilization:

If the central bank is credible, it can use its communications and policy actions to actively manage expectations, even with a neutral stance. For example, a clear commitment to future price increases can help anchor expectations and prevent a downward spiral.

In summary:

Low inflation can negatively impact inflation expectations under both adaptive and rational expectations frameworks. The impact is more pronounced under adaptive expectations, as it's based on past inflation. While a neutral central bank stance can exacerbate the issue under both frameworks, the impact is less severe under rational expectations if the central bank is credible and uses its communications effectively to manage expectations.