How Consumers View Inflation

How Consumers View Inflation
How Consumers View Inflation

With such inflation reaching levels not seen in decades, households around the world are wondering how much more they will have to pay for gasoline, groceries, and other necessities.


Their responses may assist them in making important personal financial decisions. Should they buy the new refrigerator now, rather than waiting and risking a price increase? Should they request a raise from their boss to compensate for the loss of purchasing power?


The outcomes will have an impact on the economy as a whole, not just individual households. The reason is that central bankers and academic economists see inflation as a self-fulfilling prophecy. If consumers believe prices will rise faster, they may act in ways that will fuel more inflation, such as purchasing a refrigerator or asking for a raise. More money chasing a fixed number of refrigerators raises their price, and more people asking for a raise prompts employers to raise the prices of goods or services they sell to compensate for higher labor costs.


Coffee, gas

All of this begs the question for academics and policymakers alike: how well do we understand the expectations of households? A large body of behavioral economics research has delved deep into this question over the last decade. The main findings are that households have very different perceptions of inflation and perceive it to be higher and more persistent than it is. Consumers also differ more than experts on the outlook for inflation, change their minds less frequently, and frequently rely on a few key products they consume on a regular basis—such as coffee and gasoline—to extrapolate changes in the overall cost of living. Individual expectations are also strongly related to demographic factors such as gender, age, education, and political orientation.


Shocks that are hypothetical

We used the survey to learn about people’s perceptions of how the economy works, or, in economist speak, their “subjective models.” We asked respondents to consider four hypothetical shocks to the US economy: a sharp increase in crude oil prices due to falling global supply, an increase in income taxes, an increase in federal government spending, and an increase in the Federal Reserve’s target interest rate. These shocks have received a lot of attention in macroeconomics, but they are also conceptually understandable to non-experts. To ensure that all respondents used the same information, we provided current figures for inflation and unemployment rates and asked them to forecast the two variables over the next year.


Their responses showed that beliefs about the effects of economic shocks were widely dispersed, with large differences within our samples of households and experts and between the two groups. In some cases, households and experts even disagreed on whether a particular 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 (Chart 1).

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predictions of a decrease by experts and many textbook models (Chart 1).

In the second part of the survey, we investigated the origins of disagreement between experts and households and within the two groups. Part of the disagreement seems to arise because respondents think the shocks work through different transmission channels—in particular, demand- versus supply-side mechanisms. Using a set of multiple-choice questions and open text boxes, we asked respondents to describe what they were thinking when they made their predictions. We found that these associations explained a substantial part of the differences in forecasts. Unsurprisingly, experts were most likely to rely on their technical knowledge, using frameworks taken from their everyday toolkits and often making direct reference to theoretical models or empirical studies. By contrast, households drew on a broader range of approaches in making their predictions. They were more likely to rely on personal experiences, be influenced by political views, or simply guess how a given shock might affect the economy.

Moreover, when households think of specific shock propagation mechanisms, they often come up with very different channels than experts. This in turn partly explains why their predictions for some shocks differ so markedly from those of experts. For instance, households more often thought about the impact of higher interest rates on firms’ costs of borrowing capital, which are passed on to consumers via higher prices. On the other hand, experts mostly considered the canonical demand-side channel, which predicts a decline in inflation in response to higher interest rates as consumers spend less and save more (Chart 2).

predicts a decline in inflation in response to higher interest rates as consumers spend less and save more (Chart 2).



A growing research effort, led by notable academics in the field, aims to embed behavioral features of how households form expectations in macroeconomic models, departing from classic rational expectations assumptions. This field, known as behavioral macroeconomics, is rapidly growing, but it faces significant challenges. It is math-intensive, which may limit its immediate application in policymaking. Furthermore, it is critically dependent on empirical evidence of how households reason about the macroeconomy and form expectations, which behavioral economists can only solidly build through numerous and careful studies. However, it has the potential to fundamentally shape both theoretical macroeconomics and real-world policymaking in the coming years, and communication will almost certainly play a key role in influencing expectations.