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.
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.
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.
