Hall of Mirrors: How Consumers Think about Inflation
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Bibliographic details
- Authors: Carlo Pizzinelli
- Published: July 19, 2022
Key findings on consumer expectations
- Households hold very disparate views on inflation and tend to perceive it as higher and more persistent than it usually is.
- Consumers disagree on the outlook for inflation more than experts do, change their views less often, and often rely on a few key products they consume regularly—such as 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; women and people with less education or lower incomes tend to expect higher inflation.
- Past experiences (for example, the Great Depression or the 1970s OPEC oil embargo) can strongly shape lifetime perceptions of inflation.
Survey design and scope
- Surveys conducted from 2019 to 2021.
- Samples included 6,500 US households broadly representative of the population and 1,500 experts (central bank and international financial institution staff, professors and PhD students, and financial sector economists).
- Respondents were asked to provide forecasts for inflation and unemployment over the following year given current figures, then given news about one of four hypothetical shocks and asked for revised forecasts.
- The four hypothetical shocks presented: 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.
Major empirical contrasts: households versus experts
- Beliefs about the effects of economic shocks were widely dispersed within and between the household and expert samples.
- In some cases households and experts disagreed on whether a shock had a positive or negative impact on inflation and unemployment.
- Most strikingly: households on average believed that a rise in the central bank’s policy interest rate and a rise in income taxes would increase inflation, contrary to predictions of a decrease by experts and many textbook models.
- Part of the disagreement arises because respondents conceive shocks operating through different transmission channels—demand-side versus supply-side mechanisms.
Mechanisms and reasoning differences
- Experts most often relied on technical knowledge, referencing theoretical models or empirical studies and the canonical demand-side channels (e.g., higher interest rates -> consumers spend less -> inflation declines).
- Households used a broader range of approaches: personal experiences, political views, or intuitive guesses about how shocks affect the economy.
- Households more often considered higher interest rates as increasing firms’ borrowing costs, which are passed on to consumers via higher prices—a supply-side channel that can imply higher inflation.
Communication, contextual cues, and policy relevance
- Contextual cues shaped which propagation channels individuals considered and thus their forecasts.
- Households prompted to think about demand-side channels before forecasting were more likely to predict monetary policy effects consistent with experts.
- Central banks’ efforts to make communication accessible (for example, broader social media presence and simpler language) can help steer public expectations.
- Jerome Powell (quoted): “We can’t allow a wage-price spiral to happen,” and “We can’t allow inflation expectations to become unanchored. It’s just something that we can’t allow to happen.” Powell announced a half-point increase in the Fed’s key interest rate and cited concern about expectations.
Implications for macroeconomic modeling and policy
- Canonical macroeconomic models often assume “rational expectations”: households base decisions on expectations consistent with how the economy evolves.
- Departures from rational expectations should realistically reflect how households actually form expectations to be meaningful for policy and theory.
- Behavioral macroeconomics seeks to embed features of how households form expectations into models, but faces challenges:
- It is math-intensive, which may limit immediate use in everyday policy work.
- It relies crucially on robust empirical evidence of household reasoning, requiring numerous careful studies.
- The study provides preliminary empirical directions for incorporating behavioral aspects of expectations and highlights communication as a key policy tool.
Research and dissemination notes
- Study authors include Carlo Pizzinelli, Peter Andre, Christopher Roth, and Johannes Wohlfart.
- Published material dates: F&D Magazine listing shows September 2022 and Published July 19, 2022.
- References cited in the piece include Andre and others 2022 and other forthcoming and published works noted in the text.
Source: Hall of Mirrors: How Consumers Think about Inflation — Carlo Pizzinelli; F&D Magazine; Published July 19, 2022 (September 2022 landing page).
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- Hall of Mirrors