People’s inflation expectations are rising – and it will be hard to bring down

Çconsumer prices across the rich world are growing at more than 9% a year, the highest rate since the 1980s. What is worrying is that there is mounting evidence that the public is beginning to expect consistently high inflation. Figures that suggest Americans’ medium-term inflation expectations have risen helped trigger last week’s market turmoil, which culminated in the Federal Reserve raising interest rates by three-quarters of a percentage point. Central banks urgently need to convince people that they are serious about reducing inflation. But a body of evidence suggests that changing public opinion can be extraordinarily difficult.

The difference in points of view of expert and lay groups has become yawning. Bernardo Candia, Olivier Coibion ​​and Yuriy Gorodnichenko, three economists, analyze the inflation expectations of four groups in the United States (see chart). Those from professional analysts and financial markets remain close to the Fed’s 2% target. But consumer beliefs increasingly do not. They expect prices to rise by more than 5% next year. Companies, exposed to rising costs of commodities, wages and other inputs, expect even higher inflation.

Expectations are also rising outside of America. A dataset put together by the Cleveland Fed, the Morning Consult consultancy and Raphael Schoenle of Brandeis University measures public inflation expectations in several places. In May 2021, a respondent in the median rich country thought inflation next year would be 2.3%. Now they expect a rate of 4.2%.

Central banks face a problem in lowering those expectations again. This is because few people other than investors and financial journalists pay much attention to what they say. A new paper by Alan Blinder of Princeton University and colleagues is drier. “Households and businesses have a low desire to be informed about monetary policy.” A 2014 poll found that only a quarter of Americans could choose Janet Yellen as then Fed chairman, out of a shortlist of four. Four out of ten Americans believe the Fed’s inflation target exceeds 10%. No wonder the impact of its policy announcements on inflation expectations is “hushed up,” according to a recent study by Fiorella De Fiore of the Bank for International Settlements and colleagues.

Even Americans are not alone. In the late 2000s, researchers at the Bank of Italy assessed whether people knew what inflation was. Many had only a mixed understanding – with half of respondents confusing price changes with price levels. In recent years, Japan has implemented vigorous monetary easing to increase inflation. But by 2021, more than 40% of Japanese have “never heard of” the plan, according to an official poll.

In the years before the pandemic, public apathy toward monetary policy didn’t matter much. Inflation was low and stable. Now it matters a lot. Spiraling expectations can be built into wages and prices, driving inflation even higher. The conventional tools of central bankers can do little to bring them down. Even the effect of raising interest rates is not entirely clear: Twice as many Americans believe that higher rates increase inflation than they reduce it, according to a recent study. The Economist/YouGov survey. What else can be done? History points to several options.

One is to make drastic or unexpected announcements. This could involve raising interest rates outside of scheduled meetings – a decision made by India’s central bank in May. The European Central Bank (ecb) used this trick in pursuit of another goal: keeping government bond spreads low, which would otherwise threaten a debt crisis. In 2012, Mario Draghi, then president of the bank, made an offhand promise to do “whatever it takes” to save the euro. According to research by Michael Ehrmann at ecb and Alena Wabitsch of the University of Oxford, the words generated high Twitter traffic among non-experts, suggesting they had succeeded. The genius of the statement, other research suggests, was that it focused on the end (“preserve the euro”) rather than the means (“buy bonds”), which is easier for the public to understand. O ecb tried to repeat the trick more recently, such as calling an emergency meeting to address the widening spreads.

Others played the long game. Paul Volcker, chairman of the Fed from 1979 to 1987, cultivated a reputation for what economists call an inflation “madman”: someone willing to tolerate high unemployment in order to defeat the beast. The audience finally got the message. A recent paper by Jonathon Hazell of the London School of Economics and others argues that post-Volcker “changes in beliefs about the long-term monetary regime” have proved more important than any other factor in conquering pre-Covid-19 inflation. 19. Andrew Bailey, the head of the Bank of England, has been trying to embrace his inner Volcker, giving Brits the impression that he cares more about inflation than his wages.

Public enemy number one

Another solution is the participation of politicians. This has potential downsides. Politicians often advocate wacky anti-inflation schemes like price controls. Still, they might be able to help. After all, 37% of Americans believe the president has “very” control over inflation, compared to 34% for the Fed. Volcker’s appointment by Jimmy Carter in 1979 showed that he was serious about reducing inflation. In Britain, Margaret Thatcher and her henchmen spoke harshly about price stability; her willingness to cut government budgets likely backed up those words, cooling the economy. In the United States today, President Joe Biden says that “fighting inflation” is his “top economic priority” (although he shows less inclination to tighten fiscal policy).

Public apathy toward central banks may be an indirect compliment to policymakers in the 1980s and 1990s. Nobody had to worry about inflation when it was low. Today’s policymakers are limited by that same success. To lower inflation expectations, then, they may need to try everything in their power to make people sit up and listen.

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