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Monday, April 18, 2011

Liberty Blog: What Is Driving the Recent Rise in Consumer Inflation Expectations?

Giorgio Topa, Wilbert van der Klaauw, Olivier Armantier, and Basit Zafar of the NY Fed's Liberty blog attempt to disentangle the forces behind recent increases in inflationary expectations. It appears to be oversensitivity to food and energy prices:

What Is Driving the Recent Rise in Consumer Inflation Expectations?, by Giorgio Topa, Wilbert van der Klaauw, Olivier Armantier, and Basit Zafar, NY Fed: The Thomson Reuters/University of Michigan Survey of Consumers (the “Michigan Survey” hereafter) is the main source of information regarding consumers’ expectations of future inflation in the United States. The most recent release of the Michigan Survey on March 25 drew considerable attention because it showed a large spike in year-ahead expectations for inflation: as shown in the chart below, the median rose from 3.4 to 4.6 percent and the other quartiles of responses showed similar increases. ... In this post, we draw upon the findings of an ongoing New York Fed research project to shed some light on the possible sources of the recent increase and to gauge its significance. While our research spans both short- and medium-term inflation expectations, this blog post discusses movements in short-term measures only...

Chart1

Inflation expectations are a key consideration in the conduct of modern monetary policy. ... To this end, central banks not only look at market-based measures of inflation expectations and surveys of professional forecasters and businesses, but also track surveys of consumers’ inflation expectations, including the widely followed Michigan Survey. ...
Our research shows that ... the wording of the Michigan question induces mixed interpretations, with many people thinking about the specific prices they pay in their everyday purchases, and especially those prices that undergo large changes, such as food and gasoline prices. As a result, the Michigan measure appears to reflect expectations of food and gasoline price increases to a much larger extent than is suggested by their share in household expenditures and in measures of overall inflation such as the consumer price index. ...
With this background information, we now return to our initial question: What factors could explain the recent large spike in short-term inflation expectations observed in the Michigan Survey? One possible explanation is that the observed rise in inflation expectations is tied to an expected increase in nominal wages. ... As the chart below indicates, year-ahead median wage growth expectations have remained muted since February 2009. While this is a troubling sign for wage earners’ incomes, it suggests that concerns about wages exerting second-order effects on inflation are not founded at present.

Chart3

Another possible explanation for the Michigan Survey reading is that short-term inflation expectations may be responding to concerns about accelerating growth in government debt. In our survey, we also ask respondents about their expectations for the year-ahead change in the level of government debt. We find that these expectations have actually declined in recent months, as shown in the chart below. Therefore, the recent rise in inflation expectations does not seem to be tied to an expected increase in the growth of government debt.

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Finally, our experimental survey also asks respondents about expected price changes for specific items. The last chart reports year-ahead inflation expectations for gasoline, food, medical costs, and housing costs. The survey responses point to increases in inflation expectations for food and housing costs, as well as an especially large increase in expectations for gasoline inflation. ...

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In sum, our research shows that expectations of higher nominal wage growth or concerns about increased growth of nominal government debt are unlikely to be behind the recent increase in short-term inflation expectations reported in the Michigan Survey. Instead, we suggest that this rise in inflation expectations reflects two factors: (1) sharp expected increases in food and especially gasoline prices and (2) the use of a survey question (“prices in general”) that results in reported expectations being more sensitive to these types of price change. An important open question concerns the extent to which households act on their expectations of overall inflation as well as on their expectations of specific price changes. As noted earlier, one significant area in which inflation expectations may influence consumer behavior is in the wage negotiation process, but thus far neither the “prices in general” nor the “rate of inflation” measure appears to be feeding into increases in expected future wage growth. We hope to return to this open question in a future post.
Chart data Excel 13 kb
Disclaimer
The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).

    Posted by on Monday, April 18, 2011 at 08:10 AM in Economics, Inflation, Monetary Policy | Permalink  Comments (26)


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