## A deeper understanding of how consumers think about the economy would help policymakers control inflation

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**Canonical URL:** [A deeper understanding of how consumers think about the economy would help policymakers control inflation](https://www.imf.org/-/media/files/publications/fandd/article/2022/september/pizzinelli.pdf)

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### Survey design and methodology
- Samples collected from 2019 to 2021.
- Household sample: 6,500 US households broadly representative of the population.
- Expert sample: 1,500 experts (staff at central banks and international financial institutions, professors and PhD students, and financial sector economists).
- Respondents were given current figures for rates of inflation and unemployment and asked to forecast those variables over the following year.
- Respondents were then given one of four hypothetical shocks and asked for new forecasts:
  - a sharp increase in crude oil prices as a result of falling world supply,
  - a rise in income taxes,
  - a federal government spending increase,
  - a rise in the Federal Reserve’s target interest rate.
- For surveys collected during the COVID-19 pandemic, the questionnaire was adjusted so respondents referred to how the economy functions in “normal times” rather than during the pandemic.

### Major empirical findings
- Households’ beliefs about the effects of macroeconomic shocks are widely dispersed within the household sample and between households and experts.
- Households tend to:
  - perceive inflation as higher and more persistent than it usually is,
  - disagree on the outlook for inflation more than experts do,
  - change their view less often than experts,
  - rely on a few frequently consumed products (for example, coffee and gasoline) to extrapolate changes in the overall cost of living.
- Individual expectations are strongly correlated with demographic characteristics including sex, age, education, and political orientation; for example, women and people with less education or lower incomes tend to expect higher inflation.
- Past economic experiences can strongly shape long-run perceptions of inflation (for example, living through the Great Depression or the 1970s OPEC oil embargo).

### Divergences between households and experts (key contrasts)
- On average, households believed that:
  - a rise in the central bank’s policy interest rate would increase inflation.
  - a rise in income taxes would increase inflation.
- Experts and many textbook models predict the opposite effect for those shocks (a decrease in inflation).
- Part of the disagreement stems from different beliefs about transmission channels:
  - Experts most often relied on technical knowledge and canonical demand-side channels (higher interest rates → lower spending → lower inflation).
  - Households more often invoked supply-side or pass-through channels (higher interest rates → higher firms’ borrowing costs → firms raise prices → higher inflation), personal experiences, political views, or simple guesses.

### Role of contextual cues and communication
- Prompting households to think about demand-side channels before forecasting made their predictions more likely to align with experts’ forecasts for monetary policy shocks.
- Effective, accessible communication can therefore influence which propagation channels the public considers and can shape public expectations.
- Central banks have been expanding outreach to wider audiences (for example, presence on social media and simpler language in speeches and statements) as part of a strategy to make communications more accessible.

### Implications for policymakers
- Monitoring households’ inflation expectations across time horizons (for example, three to five years) is important because increased medium-term inflation forecasts signal unanchoring of expectations and may necessitate policy action.
- Policymakers’ actions depend on their ability to convey intended effects to households to steer expectations; misinterpretation of policy actions (for example, viewing an interest rate hike as inflationary) could undermine policy objectives.
- Communication that explicitly highlights the relevant transmission channels (for example, demand-side effects of tighter monetary policy) can help align household expectations with expert models.

### Implications for macroeconomic modeling
- Canonical macroeconomic models often assume “rational expectations”: households base decisions on expectations consistent with how the economy evolves, implying that an unexpected policy rate increase expected to lower inflation will lead household actions that help lower inflation.
- Departures from rational expectations must realistically reflect how households actually form expectations.
- Behavioral macroeconomics aims to embed empirical behavioral features of expectation formation into macro models; this field is expanding but faces challenges:
  - it is math-intensive, which may limit immediate policy use,
  - it requires numerous careful empirical studies to ground behavioral assumptions.
- The study provides preliminary empirical directions for incorporating behavioral aspects of household expectations into macroeconomic models and highlights a key role for communication.

*Source: pizzinelli*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/september/pizzinelli.pdf_