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Expectations of inflation: the biasing effect of thoughts about specific prices

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  • Wändi Bruine de Bruin
  • Wilbert van der Klaauw
  • Giorgio Topa

Abstract

National surveys follow consumers’ expectations of future inflation, because they may directly affect the economic choices they make, indirectly affect macroeconomic outcomes, and be considered in monetary policy. Yet relatively little is known about how individuals form the inflation expectations they report on consumer surveys. Medians of reported inflation expectations tend to track official estimates of realized inflation, but show large disagreement between respondents, due to some expecting seemingly extreme inflation. We present two studies to examine whether individuals who consider specific price changes when forming their inflation expectations report more extreme and disagreeing inflation expectations due to focusing on specific extreme price changes. In Study 1, participants who were instructed to recall any price changes or to recall the largest price changes both thought of various items for which price changes were perceived to have been extreme. Moreover, they reported more extreme year-ahead inflation expectations and showed more disagreement than did a third group that had been asked to recall the average change in price changes. Study 2 asked participants to report their year-ahead inflation expectations, without first prompting them to recall specific price changes. Half of participants nevertheless thought of specific prices when generating their inflation expectations. Those who thought of specific prices reported more extreme and more disagreeing inflation expectations, because they were biased toward various items associated with more extreme perceived price changes. Our findings provide new insights into expectation formation processes and have implications for the design of survey-based measures of inflation.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 489.

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Date of creation: 2011
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Handle: RePEc:fip:fednsr:489

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Keywords: Consumer surveys ; Inflation (Finance) ; Prices;

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References

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  1. Andrew Ang & Geert Bekaert & Min Wei, 2006. "Do macro variables, asset markets, or surveys forecast inflation better?," Finance and Economics Discussion Series 2006-15, Board of Governors of the Federal Reserve System (U.S.).
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  7. David G. Blanchflower & Conall MacCoille, 2009. "The formation of inflation expectations: an empirical analysis for the UK," NBER Working Papers 15388, National Bureau of Economic Research, Inc.
  8. Antonides, Gerrit, 2008. "How is perceived inflation related to actual price changes in the European Union?," Journal of Economic Psychology, Elsevier, vol. 29(4), pages 417-432, August.
  9. Brachinger, Hans Wolfgang, 2008. "A new index of perceived inflation: Assumptions, method, and application to Germany," Journal of Economic Psychology, Elsevier, vol. 29(4), pages 433-457, August.
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  11. Helmut Jungermann & Hans Brachinger & Julia Belting & Katarzyna Grinberg & Elisabeth Zacharias, 2007. "The Euro Changeover and the Factors Influencing Perceived Inflation," Journal of Consumer Policy, Springer, vol. 30(4), pages 405-419, December.
  12. Ranyard, Rob & Missier, Fabio Del & Bonini, Nicolao & Duxbury, Darren & Summers, Barbara, 2008. "Perceptions and expectations of price changes and inflation: A review and conceptual framework," Journal of Economic Psychology, Elsevier, vol. 29(4), pages 378-400, August.
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Cited by:
  1. Bruine de Bruin, Wändi & van der Klaauw, Wilbert & Topa, Giorgio & Downs, Julie S. & Fischhoff, Baruch & Armantier, Olivier, 2012. "The effect of question wording on consumers’ reported inflation expectations," Journal of Economic Psychology, Elsevier, vol. 33(4), pages 749-757.
  2. Langthaler, Johannes & Valderrama, Maria Teresa & Gnan, Ernest, 2011. "Heterogeneity in Euro Area Consumers’ Inflation Expectations: Some Stylized Facts and Implications," Monetary Policy & the Economy, Oesterreichische Nationalbank (Austrian Central Bank), issue 2, pages 43–66.

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