Belief in the Transitory!
I created the above chart from the New York Fed Survey of Consumer Expectations.
Not once in 8 years did consumer expectations dip below 2%. Indeed, the lowest 1-year look ahead rate is 2.33%.
My key observation is that consumers believe inflation measures under 2% are transitory given they never predict such events looking ahead no matter what the starting point, even negative.
The New York Fed key findings do not mention my key observation but they do note that inflation expectations are now at record highs.
The SCE is a nationally representative, internet-based survey of a rotating panel of approximately 1,300 household heads. Respondents participate in the panel for up to 12 months, with a roughly equal number rotating in and out of the panel each month. Unlike comparable surveys based on repeated cross-sections with a different set of respondents in each wave, our panel allows us to observe the changes in expectations and behavior of the same individuals over time.
Inflation Data Description
- Median one-year ahead expected inflation rate: Respondents are asked for the percent chance that, over the next 12 months, the rate of inflation (deflation) will be 12% or higher; between 8% and 12%; between 4% and 8%; between 2% and 4%; between 0 and 2%. A generalized beta distribution is fitted to the responses of each survey participant and the mean of this distribution is calculated. This is the respondent’s “expected inflation rate”.
- Median point prediction: Respondents are asked what they think the rate of inflation will be over the next 12 months. This is a point prediction (a single-value forecast).
The three-year forecasts are for three years instead of one.
Reported Key Inflation Findings
- Median one-year-ahead inflation expectations increased by 0.6 percentage point in May to 4.0%, the seventh consecutive monthly increase and a new series high. Median inflation expectations at the three-year horizon increased from 3.1% to 3.6%, the second-highest level in this series, behind only the reading from August 2013. The increase at both horizons is particularly pronounced among respondents age 60 and over and among those with a high school degree or less.
- Median inflation uncertainty—or the uncertainty expressed regarding future inflation outcomes—increased sharply at the short- and medium-term horizons. Both measures are well above the levels observed before the outbreak of COVID-19.
- Median year-ahead home price change expectations increased by 0.7 percentage point to 6.2%, substantially above the 2020 average of 2.3% and marking a third consecutive month with a new series high. The May increase was driven mostly by respondents who live in the “West” and “South” Census regions.
- Expectations about year-ahead price changes increased for all commodities in May. The median one-year-ahead expected change in the price of food and rent increased by 2.2 and 0.3 percentage points, respectively, to new series highs of 8.0% and 9.7%. The median one-year-ahead expected change in the price of gas and in the cost of medical care rebounded by 0.6 and 0.3 percentage point, respectively, to 9.8% and 9.4%. Finally, the median one-year-ahead expected change in the cost of a college education increased by 0.2 percentage point to 6.1%.
Inflation Expectations vs Year-Over-Year Inflation Measures Detail
After drifting sideways near the 3% mark, consumers started penciling in higher inflation expectations in March of 2021 and higher point predictions in December of 2020.
Parroting the News?
One has to wonder how much of this is real opinion vs constant news recently of higher prices.
I suspect a bit of both as prices have gone up, but either way it's irrelevant, because:
Inflation Expectations Are Meaningless
Contrary to widespread belief that inflation expectations matter, they are actually meaningless and the above charts show just that.
For most of eight years reported inflation was under 2% and often under 1%, and briefly negative. Yet, the look ahead median point prediction was never below 2.9%.
If expectations mattered, why did the CPI and PCE stay below 2% so long?
On March 8, 2019 in a speech called Monetary Policy: Normalization and the Road Ahead Fed Chair Jerome Powell stated "Persistently weak inflation could lead inflation expectations to drift downward."
Other than the humorous idea the Fed was about to normalize, the key question is "So what?"
A look at CPI components shows how silly it is to believe in inflation expectations.
CPI Percentage Weights
I highlighted inelastic items.
Perhaps a portion of education is elastic. But a portion of other housing is inelastic as is a portion of communication and other goods.
Recreation is elastic and so is apparel (assuming one does not ruin one's only coat or shoes).
Somewhere between 80% and 90% of household purchases are inelastic.
Inelastic Item Questions
Q: If consumers think the price of food will drop, will they stop eating? Will they eat twice as much if they expect prices will rise?
Q: If consumers think the price of gas will drop, will they stop driving?
Q: If consumers think the price of rent will drop, will they hold off renting until that happens? Will they rent two apartments if they expect the price to rise?
Q: Will consumers delay medical services if they think prices will drop? Will they have two operations if they think prices will rise?
Elastic Item Questions
Q. Better deals on TVs and computers are always around the corner. Does that stop TV and computer purchases?
Q. If someone wants a new refrigerator, toaster, or stove will they wait two months if they think prices will decline?
Asset prices are a different matter, however.
Asset Price Expectations
- People do buy stocks it they believe prices will rise. They avoid stocks or sell them if they expect prices will drop.
- People will stretch to buy a home if they expect prices to rise. They wait if they expect prices will drop.
Note that every member of the Fed talks about expectations that don't matter ignoring those that do matter.
And not only does the Fed ignore asset price expectations, they ignore asset prices totally. That's how you get three enormous bubbles in 20 years.
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