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.
Key Findings
- According to the French survey, the share of households expecting stable prices fluctuates greatly over time and consistently with realized inflation.
- Changes in the share of households expecting positive inflation instead of stable prices account for nearly 75 percent of the variance in the average inflation expectation. This implies that changes in the average expected inflation among households expecting positive inflation contributes much less to the variance in the average inflation expectation.
- The share of households expecting stable prices decreases when realized inflation declines. This correlation is stronger when realized inflation is low, typically below 2 percent.
- Households expecting positive inflation over the next year have a higher probability of buying new durable goods in the current year compared with households expecting that prices will remain stable.
- Households with different positive inflation expectations for the next year have a similar probability of buying durable goods in the current year.
Implications
The distribution of households’ inflation expectations may be widely dispersed, but they are still informative, particularly because they indicate the share of households expecting prices to remain stable. Additionally, the finding that households discretize their views on future inflation suggests that central banks’ ability to manage current aggregate demand by manipulating inflation expectations is more limited in practice than it is in models where inflation expectations react continuously to news. The finding indicates that to be effective, forward guidance policies must convince those households expecting that prices will remain stable to switch to a positive inflation regime. Furthermore, the stimulative effect of forward guidance is capped once all households expect positive inflation; expectations of higher inflation do not lead to additional consumption. The finding regarding discretization also suggests that inflation expectations can de-anchor even if they remain positive on average. De-anchoring would occur when a large enough share of households expects prices to stay about the same, thus putting a persistent drag on aggregate demand. For expectations to reanchor, a substantial share of households has to switch to a positive inflation regime.
Abstract
We provide evidence that households discretize their inflation expectations so that what matters for durable consumption decisions is the broad inflation regime they expect. Using survey data, we document that a large share of the adjustment in the average inflation expectation comes from the change in the share of households expecting stable prices; these households also consume relatively less than the ones expecting positive inflation. In contrast, variations of expectations across households expecting a positive inflation rate are associated with much smaller differences in individual durable consumption choices. We illustrate how this mitigates the expectation channel of monetary policy.