Inflation Expectations: A Skeptical Survey

One thing we know Inflation expectations Federal Reserve Chairman Jerome Powell relies heavily on them. He thinks about expectations, lectures on them, and uses data series when formulating Federal Reserve policies to combat inflation.

The problem is that all consumer surveys (including inflation expectations) are deeply problematic. At the very least, they are working backward, a step backwards. You can see this in the FRBNY chart of inflation expectations above, where higher price expectations peak in the next 1 and 3 years after inflation itself reaches new highs.

what only Happenings always have a big impact on what consumers expect willpower will happen in the future. Recency Bias leads investors to make the same error, because they focus on what just happened.

consideration: Asking investors about their risk tolerance usually does not accurately describe their true tolerance for drawdowns and low returns; Instead, we get a number highly dependent on the performance of the equity market over the previous three to six months. Ask any investor their tolerance for risk in the fourth quarter of 2021 and you will hear a very different answer than if you ask the same investor in the second quarter of 2022. Their risk tolerance has not changed, but the short-term market environment has; This is of course irrelevant to their long-term investment needs.

Do you imagine for a moment that the people asked by the Federal Reserve Bank of New York in its inflation expectations survey behave differently?

I have a sneaking suspicion that inflation expectations are overly dependent on the 6-foot-tall numbers posted nationwide on roadsides that show the price of a commodity that used to be a very important part of the household budget but today is a much smaller part of consumer spending. . With gasoline prices falling for 98 days in a row, it’s no surprise that inflation expectations have also fallen.

Anyway, here’s FRBNY:

Both median one- and three-year-ahead inflation expectations posted sharp declines in August, to 5.7 percent and 2.8 percent, respectively, from 6.2 percent and 3.2 percent in July. The median five-year-ahead inflation expectation, which has been published in the monthly SCE Core survey on an ad-hoc basis since earlier this year and was first published in July, also fell to 2.0 percent from 2.3 percent. Expectations about year-ahead price increases for gas also tend to decline, with households expecting gas prices to remain roughly unchanged a year from now.

The good news is that expectations are coming down; The bad news is that real-world inflation will likely peak 3-6 months after but earlier than the FOMC has acknowledged. This presents the risk that the Federal Reserve will raise rates and tighten credit excessively, leading to high unemployment and possible recession, where neither is needed.

Regardless, this is an area of ​​research for further exploration. I hope to address this in more detail in the coming weeks…

in the past:
How overrated is sentiment in the economy? (November 22, 2009)

Black Friday #fail

formula:
Inflation expectations continue to decline over the short, medium, and long-term horizons
Consumer Expectations Survey
FRBNY, Microeconomic Data Center (August 2022 data)

Expectations of commodity price changes a year ahead

Expect house prices to change

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