Mathieu Pedemonte

We implement a novel methodology to disentangle two-way causality in inflation and income expectations in a large, nationally representative survey of US consumers. We find a 20 percent passthrough from expected inflation to expected income growth, but no statistically significant effect in the other direction. Passthrough is higher for higher-income individuals and men. Higher inflation expectations increase consumers’ likelihood to search for higher-paying new jobs. In a calibrated search-and-matching model, dampened responses of wages to demand and supply shocks translate into greater output fluctuations. The survey results and model analysis provide a labor market channel for why people dislike inflation.

We show that inflation expectations are heterogeneous and depend on past individual experiences. We propose a diagnostic expectations-augmented Kalman filter to represent consumers’ heterogeneous inflation expectations-formation process, where heterogeneity comes from an anchoring-to-the-past mechanism. We estimate the diagnosticity parameter that governs the inflation expectations-formation process and show that the model can replicate systematic differences in inflation expectations across cohorts in the US. We introduce this mechanism into a New Keynesian model and find that heterogeneous expectations anchor aggregate responses to the agents’ memory, making shocks more persistent. Central banks should be more active to prevent agents from remembering current shocks far into the future.

Motivated by the dominant role of the US dollar, we explore how monetary policy (MP) shocks in the US can affect a small open economy through the expectation channel. We combine data from a panel survey of firms' expectations in Uruguay with granular information about firms' debt position and total imports on a monthly basis. We show that a contractionary MP shock in the US reduces firms' inflation and cost expectations in Uruguay. This result contrasts with the inflationary effect of this shock on the Uruguayan economy, suggesting uncertainty about the policy regime. We discuss the issues and challenges of this expectation channel.

Based on indirect utility theory, we introduce a novel methodology of measuring inflation expectations indirectly. This methodology starts at the individual level, asking consumers about the change in income required to buy the same amounts of goods and services one year ahead. Analytically, our methodology possesses smaller ex-post aggregate inflation forecast errors relative to forecasts based on conventional survey questions. We ask this question in a large-scale, high-frequency survey of consumers in the US and 14 countries, and we show that indirect consumer inflation expectations perform well along several empirical dimensions. Exploiting the geographically detailed, high-frequency variation in the data, we then show that individual experiences matter for inflation expectations, in a nuanced way. For example, age and gender have different effects internationally, while individual inflation and local experiences are generally highly relevant. In an application to gasoline price changes, we identify large effects of experienced gasoline price changes on inflation expectations, characterized by both overreaction and persistence.

Using a novel experimental setup, we study the direction of causality between consumers’ inflation expectations and their income growth expectations. In a large, nationally representative survey of US consumers, we find that the rate of passthrough from expected inflation to expected income growth is incomplete, on the order of 20 percent. There is no statistically significant effect going in the other direction. Passthrough varies systematically with demographic and socioeconomic factors, with greater passthrough for higher-income individuals than lower-income individuals, although it is still incomplete. Higher inflation expectations also cause consumers to report a higher probability that they will search for a new job that pays more. Using our survey findings to calibrate a search-and-matching model, we find that dampened responses of real wages to demand and supply shocks translate into greater fluctuations in output. Taken together, the survey results and model exercises provide a labor market channel to explain why people dislike inflation.

We study the differential regional effects of monetary policy exploiting geographical heterogeneity in income across cities in the United States. We find that prices and employment in poorer cities react more to monetary policy shocks. The results for prices hold for a wide range of narrow consumer expenditure categories. The results are consistent with New Keynesian models that allow for a differential share of hand-to-mouth consumers across regions, but not with models in which regions have different slopes of the Phillips curve. We show that an increase in heterogeneity across cities amplifies the effect of monetary policy on prices and employment.

Flexible exchange rates can facilitate price adjustments that buffer macroeconomic shocks. We test this hypothesis using adjustments to the gold standard during the Great Depression. Using prices at the goods level, we estimate exchange rate pass-through. Using novel monthly data on city-level economic activity, combined with employment composition and sectoral export data, we show that American exporting cities were significantly affected by changes in bilateral exchange rates. With those results we calibrate a general equilibrium model to obtain aggregate effects from cross-sectional estimates. We show that the gold standard deepened the Great Depression, and abandoning it was a key driver of the economic recovery.

Flexible exchange rates can facilitate price adjustments that buffer macroeconomic shocks. We test this hypothesis using adjustments to the gold standard during the Great Depression. Using prices at the goods level, we estimate exchange rate pass-through and find gains in competitiveness after a depreciation. Using novel monthly data on city-level economic activity, combined with employment composition and sectoral export data, we show that American exporting cities were significantly affected by changes in bilateral exchange rates. They were negatively impacted when the UK abandoned the gold standard in 1931 and benefited when the US left the gold standard in April 1933. We show that the gold standard deepened the Great Depression, and abandoning it was a key driver of the economic recovery.

This paper shows how policy announcements can be used to manage expectations and have a role as a policy tool. Using regional variation in radio exposure, I evaluate the impact of President Franklin D. Roosevelt’s 1935 Fireside Chat, in which he showcased the introduction of important social policies, establishing a new cycle of the New Deal. I document that cities with higher exposure to the announcement exhibited a significant increase in spending on durable goods. I provide evidence that this result is not driven by wealth or other potentially confounding variables. The estimated effect is consistent with changes in expectations toward the policies announced. This paper shows the power of communication as a policy tool in affecting economic activity.

Inflation expectations have an impact on one’s economic behavior. We show that the inflation expectations of professional forecasters and consumers are predicted by very different prices. While professional forecasters weigh prices similar to the consumer price index, consumers seem to focus on prices they see more often, such as those for food and new vehicles. These are also prices that have seen disproportionally high volatility since the onset of the pandemic. We argue that heterogeneity in the importance of component-specific inflation can have relevant economic implications and disproportionate effects on consumers’ inflation expectations that can, in turn, affect economic behavior.

Surveys often measure consumers’ inflation expectations by asking directly about prices in general or overall inflation, concepts that may not be well-defined for some individuals. In this Commentary, we propose a new, indirect way of measuring consumer inflation expectations: Given consumers’ expectations about developments in prices of goods and services during the next 12 months, we ask them how their incomes would have to change to make them equally well-off relative to their current situation such that they could buy the same amount of goods and services as they can today. Using a massive number of survey responses at a high frequency, we show that this measure of indirect consumer inflation expectations has risen sharply since early 2021. Higher inflation experiences correlate with higher indirect consumer inflation expectations across US cities and around the world.