Understanding Expectations Formation for Hand-to-Mouth Households: Lessons from the Financial Crisis

We study how poor hand-to-mouth and wealthy hand-to-mouth households form their expectations as compared to wealthy liquid households in the United States, using monthly microeconomic survey data for the period from 2005:2 to 2013:6. Utilizing a timeline of financial crisis events along with changes in stock-market values and uncertainty around those events, we assess the responses of these households’ expectations regarding inflation, unemployment, and the interest rate. Our estimates imply differences in the formation of expectations for liquidity constrained households relative to unconstrained ones. While adverse financial crisis events that lower future inflation do not affect inflation expectations for all households, wealthy hand-to-mouth households tend to revise their inflation expectations downwards substantially. This suggests they decipher these financial events’ noisy signal regarding lower future inflation more accurately than other types of households, in line with having a greater incentive to do so.