Rational inattention to inflation among New Zealand households

This analytical note looks at how New Zealand households’ inflation expectations respond to changing prices — what inflation is now and how that shapes what people think it will be in future. Key findings - This Note presents empirical evidence suggesting that New Zealand households tend to pay more attention to inflation when it is high than when it is low. In the academic literature, this is known as rational inattention. - Rational inattention can result in a non-linear relationship between actual inflation and households’ inflation expectations. Once inflation rate rises above a certain threshold, for example, 2%, household inflation expectations line up closely with actual inflation. Thus, inflation expectations may be slow to respond to monetary policy announcements, and this may make it more difficult for the central bank to rein in high inflation by raising interest rates. - It is important for monetary policymakers to monitor this potential non-linearity in how households perceive and internalise inflation data. The Analytical Notes series encompasses a range of background papers prepared by Reserve Bank staff. Unless otherwise stated, views expressed are those of the authors, and do not necessarily represent the views of the Reserve Bank.