U.S. Inflation Expectations During the Pandemic

IMF Working Papers, February 9, 2024

Source details

The distribution of consumer inflation expectations at one-year and five-ten year horizons has widened since the surge of inflation during 2021, along with the mean.
Persistently high and heterogeneous expectations of consumers with less education and lower income are mainly responsible for the widening and higher mean.
Inflation expectations of low income and female consumers are consistent with using less complex forecasting models and are more backward-looking.
A simple model of adaptive learning can mimic the change in inflation expectations over time for different demographic groups.
A medium-scale DSGE model with adaptive learning, estimated during 1965-2022, has a time-varying solution that produces lower forecast errors for inflation than a variant with rational expectations.
The estimated model interprets the surge of inflation in 2021 mainly as the result of a price markup shock, which is more persistent and requires a larger and more persistent monetary policy response than under rational expectations.

Micro-level data source: University of Michigan Survey of Consumers.
Key observed patterns:
- Widening of expectation distributions at one-year and five-ten year horizons.
- Demographic heterogeneity concentrated among consumers with less education and lower income.
- Gender differences: female consumers’ expectations are more backward-looking.

Behavioral representation: simple adaptive learning models replicate group-level evolution of expectations.
Structural model: medium-scale DSGE model with adaptive learning, estimated over 1965-2022, yields a time-varying solution.
Model comparison:
- Adaptive-learning DSGE model produces lower forecast errors for inflation than a rational-expectations variant.
- The surge of inflation in 2021 is best interpreted in the model as a price markup shock that is more persistent under adaptive learning.

The persistence and nature of the 2021 inflation surge (interpreted as a persistent price markup shock) imply:
- A larger monetary policy response is required than would be suggested under rational expectations.
- Monetary policy may need to be more persistent to address inflation driven by persistent markup shocks.
Heterogeneous and backward-looking expectations among low income and female consumers suggest targeted communication and policy measures may help anchor expectations.