New Boston Fed paper: High inflation turns heads and can tilt expectations New Boston Fed paper: High inflation turns heads and can tilt expectations

Consumers watch inflation more closely when it rises, potentially adding fuel to the fire Consumers watch inflation more closely when it rises, potentially adding fuel to the fire

March 22, 2022

If you’re spending more time reading and listening to news about inflation lately, you’re not alone. A new study by Jenny Tang and Anat Bracha introduces a novel way to measure attention to inflation among U.S. consumers. With this new method, the authors show that attention is low when the inflation rate is low and that consumers focus more on inflation when the rate rises, which may fuel higher inflation. This finding is especially important now, when inflation has reached its highest level and made its steepest 12-month climb in 40 years.

Tang is a senior economist and policy advisor at the Federal Reserve Bank of Boston. Bracha is an associate professor at the Hebrew University of Jerusalem Business School and a visiting scholar at the Boston Fed.

The paper is titled “Inflation Levels and (In)Attention.” Its findings are based on data from the University of Michigan Surveys of Consumers covering the period from 1982 through 2021. The authors looked at responses over those four decades to survey questions concerning inflation. Attention to inflation is difficult to measure through these surveys because they ask only for respondents’ forecasts of future inflation, which are influenced by many factors other than attention. The authors identify a subgroup of respondents who are indirectly asked for an estimate of current inflation and focus on their answers. Respondents who admitted to not knowing the current inflation rate are considered to have not paid attention to news reports and other information about inflation.

Attention or inattention is an important factor because it determines how much information consumers take in as they form their expectations about whether the inflation rate will remain steady, fall, or rise. And those expectations could affect, for example, how much consumers will spend and the wages they will accept.

“Forming expectations is essential for optimal decision making and, as such, is at the core of economic behavior,” Tang and Bracha write. “In macroeconomics, expectations about future economic conditions are key because they affect consumers’, investors’, and firms’ decisions, and these decisions, in turn, drive macroeconomic outcomes.”

When inflation is high, expectations are closely tied to news about inflation

The paper’s findings indicate that when inflation is low, consumers’ expectations are more anchored – they don’t change much regardless of the information that’s available, because consumers pay little attention to that information. This can be stabilizing for inflation, because spending and wages (and therefore future prices that businesses set) are less responsive to changes in economic conditions.

When inflation is high, consumers are paying more attention to media coverage of inflation, and their expectations are closely tied to that information. However, continued high inflation creates the potential for a snowball effect. As consumers receive more information about high inflation, they could increasingly expect inflation to remain high or continue rising, and as noted, those expectations could influence their decisions about spending and wages. “This is significant in our current pandemic-related acceleration of inflation,” the authors write.

Tang and Bracha note that, according to the responses to the Michigan survey, from the start of the COVID-19 pandemic in February 2020 to November 2021 (the paper’s last observation), long-term consumer inflation expectations rose at a rate that was unprecedented since the survey began asking about inflation in 1979.

“Going forward,” they write, “the increase in consumers’ – and workers’ – attention to inflation as inflation rises will be an important determinant of whether we enter into a wage-price spiral as occurred in the 1970s.” That’s when rising wages created more disposable income and greater demand for goods, which led to higher prices, which increased the demand for higher wages, which led to higher production costs and even higher prices.

High inflation is associated with an increase in news coverage of inflation

Why do consumers pay more attention when inflation is high? The authors suggest it is because consumers have more at stake under those conditions and therefore more incentive to seek information about inflation. “Since inflation tends to lower real wealth, individuals’ marginal value of wealth tends to be high when inflation is high, thus potentially increasing their marginal value of more accurate inflation assessments,” they write.

Tang and Bracha also find that higher inflation – and greater attention to inflation – is associated with an increase in news reporting about inflation. So, in addition to wanting more information when inflation is high, consumers find it easier to obtain information.

“Of course, media reporting itself is still very much related to consumer attention,” the authors write. “It can be driven by the attention that journalists – who are also consumers – pay to inflation, and it can also reflect news outlets’ responses to consumer attention, supplying news about topics that readers care about.”

Find the new paper here.

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