Are Household Inflation Expectations De-anchoring?
IMF News, May 17, 2022
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- Published: May 17, 2022
Overview
- Inflation has been increasing around the world over the past year, affecting both advanced economies and emerging markets, with conditions varying greatly across individual countries.
- Headline inflation increases have been most pronounced, but measures of core inflation have also risen markedly in many countries.
- Drivers include strong demand amid the recovery from the pandemic (often compounded by substantial policy stimulus), pandemic-related supply bottlenecks, a shift in spending toward goods (causing goods prices to outpace services prices), sharp increases in energy and food prices, and the war in Ukraine amplifying pressures.
Comparison across time horizons
- One-year horizon:
- Median household expectations and professional forecasters’ expectations have been rising sharply at the 1-year time horizon in the United States, tracking actual inflation.
- Distributions of point forecasts of 1-year ahead inflation have shifted rightward since 2019 in the United States, the United Kingdom, Germany, and Canada, with more households expecting higher inflation outcomes.
- In the United States, United Kingdom, and Canada, a significant share of households are expecting inflation greater than 10 percent one year out.
- Five-year horizon:
- Developments at the 5-year time horizon are more muted than at the 1-year horizon, but median inflation expectations have risen at the longer time horizons as well.
- Market-based measures (inflation breakevens) show a very strong increase at the 5-year time horizon in both the United States and the euro area.
- 5-year-5-year forward inflation breakevens (the second half of the 10-year maturity spectrum) show significant movement in the United States and euro area, driven mainly by higher inflation risk premia since the invasion of Ukraine, though the expected inflation component has also started to rise.
- For household 5-year expectations: Canada appears rather well-anchored; the United States, the United Kingdom, and Germany show shifts that could signal the beginning of de-anchoring.
Household survey findings (United States, United Kingdom, Germany, Canada)
- Data sources:
- United States: Michigan Survey.
- United Kingdom: Bank of England survey.
- Canada and Germany: additional survey data provided by the Bank of Canada and the German Bundesbank.
- Key patterns:
- At the 1-year time horizon, household expectation distributions have moved rightward, indicating more households expect higher inflation.
- At the 5-year time horizon, the picture is mixed across countries; notable shifts in the United States, the United Kingdom, and Germany may indicate emerging de-anchoring risk.
- Relevance of household expectations:
- Household expectations matter for consumption and saving decisions, and for financing and home-ownership decisions.
- Theoretically, household expectations should affect wage negotiations and labor supply decisions, though more empirical research is needed to establish this link.
- Household expectations are relatively closely aligned with expectations of small- and medium-sized enterprises, serving as a proxy for inflation expectations informing investment, hiring, and price-setting decisions of smaller firms.
- Median household expectations often have somewhat less predictive power than other measures, but changes in the distribution of household expectations can provide important signals.
Assessing predictive power and early-warning signals
- IMF research on US Michigan survey micro-data finds:
- Changes in US household expectations at the 1-year horizon contain important information about future inflation and potential de-anchoring.
- Information is contained in the shapes of the distribution; examining micro-data is necessary rather than relying solely on averages.
- Changes in median, variance, skewness, and kurtosis of household expectation distributions all have very substantial predictive power for one-year ahead inflation.
- These results hold even after including market-based expectations and expectations of professional forecasters, indicating household expectations add considerable information over other measures.
- Disagreement among households:
- Higher disagreement among households on near-term (1-year) inflation prospects predicts increases in future 5-year expectations.
- Higher disagreement on 1-year expectations may serve as an early warning sign of de-anchoring risk.
- Consistency with other findings:
- Shifts in the distribution of inflation expectations have presaged a rise in mean inflation in US data, reinforcing concern about observed distributional shifts across major advanced economies.
Conclusions and policy recommendations
- Household inflation expectations and their distributions contain valuable information about future inflation trends and the potential de-anchoring of longer-term inflation expectations.
- Household expectations are useful complements to market-implied inflation measures and surveys of professional forecasters.
- Recent developments in Canada, Germany, the United States, and the United Kingdom suggest expectations have started to shift in both obvious and more subtle ways; recent moves in 5-year expectations in the United States, the United Kingdom, and Germany may be particularly concerning.
- Policy recommendation:
- Advanced-economy central banks need to remain very alert to such shifts in inflation expectations and take decisive policy action to rein in inflation and ensure that expectations remain appropriately anchored.
Source: Speech by Tobias Adrian, Financial Counsellor and Director of the Monetary and Capital Markets Department, IMF; European Banking Institute; May 17, 2022.