What Matters in Households’ Inflation Expectations?
Although central banks rely on inflation expectations as a channel to manage aggregate demand—in particular to increase households’ incentive to consume rather than save by committing to policy that raises expected inflation—it’s not clear how the channel operates, as data indicate that households are poorly informed about current and future inflation. Household survey data, which central banks closely monitor, show that a significant share of respondents have expectations that are far beyond the range of realized inflation. These findings call into question the role that inflation expectation play in households’ consumption decisions and thus the role they play in the transmission of monetary policy.
To study whether inflation expectations really matter for households’ decisions and, consequently, for the transmission of monetary policy, the authors use individual data from a French survey covering about 2,000 households every month. (They test their findings on similar surveys of German and US households.) Among other information, the French survey provides detailed qualitative and quantitative information on households’ perceived and expected inflation.
The authors’ main finding is that consumption choices are affected by the broad inflation regime—not the precise inflation rate—that households expect. The relevance of different broad inflation regimes is consistent with the notion that households discretize their inflation expectations. As the authors illustrate, the inflation expectation channel is less powerful under such discretization than it is in the standard New Keynesian model used for monetary policy analysis.