Consumers Expectations of Short-Term Inflation Rise

Median short-term consumer expectations of inflation have gone up 50 basis points between February and March 2023, according to survey data from the Federal Reserve Bank of New York. That’s the first increase in inflation expectation since October 2022. But uncertainty about one-year-ahead inflation also increased.

“Median inflation expectations increased by 0.1 percentage point at the three-year-ahead horizon to 2.8%, but decreased by 0.1 percentage point at the five-year-ahead horizon to 2.5%,” the report said. “The survey’s measure of disagreement across respondents (the difference between the 75th and 25th percentile of inflation expectations) increased at all three horizons.”

Expectations are important because of public psychology. “Inflation expectations are simply the rate at which people—consumers, businesses, investors—expect prices to rise in the future,” the Brookings Institution wrote in 2022. “They matter because actual inflation depends, in part, on what we expect it to be. If everyone expects prices to rise, say, 3 percent over the next year, businesses will want to raise prices by (at least) 3 percent, and workers and their unions will want similar-sized raises. All else equal, if inflation expectations rise by one percentage point, actual inflation will tend to rise by one percentage point as well.”

In other words, people won’t be surprised if inflation is at the level they expect and will anticipate it. That can turn into an economic force of its own.

“If economic agents, such as households and firms, expect higher inflation in the future, the rational reaction is to purchase goods and services right away in order to avoid higher future prices,” the Federal Reserve Bank of St. Louis wrote last year. “As a result, the demand for goods and services immediately rises and so does the price level, which results in higher inflation right away. Hence, the Federal Reserve needs to anchor economic agents’ long-term inflation expectations close to the inflation target in order to effectively combat inflation. This blog post looks at the recent movements in so-called market-based inflation expectations for various time horizons.”

And thus comes the need to strongly set consumer expectations at the inflation levels the Fed is aiming for, like a reverse wisdom of the crowds. In the case, Fed officials want to get the public to think a certain way because consumers are capable of doing what the Fed has great difficulty in achieving: the ability to set inflation levels.

The uptick in consumer expectations therefore is a point of concern. If things were moving back to the Fed’s desired 2% inflation rate, expectations were supposed to move in the same way, not the opposite.