Inflation Thresholds and Inattention
Inflation expectations—which are a gauge of how much economic agents anticipate prices will change in the near future—help determine the level of economic activity. The classic Phillips curve relationship first developed in the late 1950s contends that unemployment rates lower than the NAIRU (nonaccelerating inflation rate of unemployment) risk driving up the price level via higher inflation. Yet two very recent studies by Coibion and Gorodnichenko (2018) and Doser et al. (2018) have shown that incorporating consumer inflation expectations, as measured by the University of Michigan’s Survey of Consumers (MSC), can explain why the Phillips curve relationship seems to have become flatter over the past two decades. They show that after accounting for consumer inflation expectations, the inflation-employment relationship appears stable, and the well-anchoring of these expectations also explains why there was no disinflation (negative inflation) during the Great Recession.
Many theories, such as full information rational expectations and adaptive expectations (learning from past experience), have been offered to account for how consumers shape their expectations about future inflation. Another hypothesis is the idea of inattention. Yet in the context of consumers’ inflation expectations, direct empirical evidence documenting the extent of inattention over a long period of time in the United States is very scarce: Coibion, Gorodnichenko, and Kumar (2018) find evidence of inattention based on firm-level data, while Cavallo, Cruces, and Perez-Truglia (2017) present experimental evidence comparing consumer attention to inflation at one given point in time in countries that have experienced bouts of high or low inflation. In order to judge how well consumers form one-year ahead inflation expectations, the authors exploit information obtained from the MSC to construct three direct measures of inattention to current inflation. The first measure is novel to the literature, as it captures respondents initially predicting that prices will go up over the next 12 months at the same annual inflation rate as the current one, then upon probing further, they reveal that they actually do not know what the current inflation rate is. These “Same-Don’t Know” (Same-DK) responses are analyzed using MSC data spanning several decades, thus capturing a range of different US macroeconomic conditions.