Inflation Expectations and Consumption Expenditure

We document a positive cross-sectional association between households' inflation expectations and their willingness to purchase durable consumption goods. Households that expect inflation to increase are 8% more likely to have a positive spending attitude compared to households that expect constant or decreasing inflation. This positive association is higher for more educated households, working-age households, high-income households, and urban households. We use novel German survey data for the period from 2000 to 2013 to establish these facts. To obtain identification, we exploit an unexpected shock to households' inflation expectations: the newly-appointed administration unexpectedly announced in November 2005 a three percentage point increase in the value-added tax (VAT) effective in 2007. The unexpected VAT increase led to an exogenous increase in inflation expectations which had a large positive effect on the willingness to spend on durables. Our findings suggest that fiscal and monetary policy measures that engineer higher inflation expectations may be successful in stimulating consumption expenditures.