Cconsumer prices across the rich world they are rising by more than 9% year on year, the highest rate since the 1980s. Worryingly, there is mounting evidence that the public is beginning to expect consistently high inflation. Figures suggesting Americans’ medium-term inflation expectations had risen helped trigger last week’s market turmoil, culminating in the Federal Reserve raising interest rates by three-quarters of a percentage point. Central banks urgently need to convince people that they are serious about reducing inflation. But a variety of evidence suggests that changing public opinion could be extraordinarily difficult.
The difference in the points of view of the groups of experts and laymen has become enormous. Bernardo Candia, Olivier Coibion and Yuriy Gorodnichenko, three economists, analyze the inflation expectations of four groups in the United States (see graph). Those of professional forecasters and financial markets remain close to the Fed’s 2% target. But consumer beliefs increasingly do not. They expect prices to rise more than 5% over the next year. Companies, exposed to rising costs of raw materials, wages and other inputs, expect even higher inflation.
Expectations are also rising outside the United States. A data set produced by the Cleveland Fed, Morning Consult, a consultancy, and Raphael Schoenle of Brandeis University measures public inflation expectations in various places. In May 2021, one respondent in the median rich country thought inflation over the next year would be 2.3%. Now they expect a rate of 4.2%.
Central banks face the problem of lowering these expectations again. This is because few people, other than investors and financial journalists, pay much attention to what they say. A new paper by Alan Blinder of Princeton University and his colleagues puts it drier. “Households and businesses have a low desire to be informed about monetary policy.” A 2014 poll found that only a quarter of Americans could choose Janet Yellen as then Fed chair, out of a list of four. Four out of ten Americans believe that the Fed’s inflation target exceeds 10%. Not surprisingly, the impact of his policy announcements on inflation expectations is “silent,” according to a recent study by Fiorella De Fiore of the Bank for International Settlements and colleagues.
Americans are not alone either. In the late 2000s, researchers at the Bank of Italy tested whether people knew what inflation was. Many had only a vague understanding: Half of the respondents confused price changes with price levels. In recent years, Japan has implemented aggressive monetary easing to boost inflation. But by 2021, more than 40% of Japanese have “never heard of” the plan, according to an official survey.
In the years before the pandemic, public apathy toward monetary policy didn’t matter much. Inflation was low and stable. Now it matters a lot. Spiraling expectations could embed themselves in wages and prices, pushing headline inflation even higher. Conventional central bankers’ toolkits can do little to bring them down. Even the effect of raising interest rates isn’t entirely clear: Twice as many Americans believe higher rates increase rather than reduce inflation, according to a recent study. The Economist/YouGov survey. What else can be done? History points to several options.
One is to make drastic or unexpected announcements. This could involve raising interest rates outside of scheduled meetings, a decision made by India’s central bank in May. The European Central Bank (ecb) has used this trick in pursuit of another goal: keeping government bond spreads low, which would otherwise threaten a debt crisis. In 2012, Mario Draghi, then head of the bank, made an impromptu promise to do “whatever it takes” to save the euro. According to research by Michael Ehrmann of the ecb and Alena Wabitsch of the University of Oxford, the words generated a lot of traffic on Twitter among non-experts, suggesting that they had found their way. The genius of the statement, other research suggests, was that it focused on the end (“preserving the euro”) rather than the means (“buying bonds”), which is easier for the public to understand. the ecb it has tried to repeat the trick more recently, for example by calling an emergency meeting to address widening spreads.
Others have played the long game. Paul Volcker, Fed chairman from 1979 to 1987, cultivated a reputation as what economists call an inflation “nut” — someone willing to tolerate high unemployment to defeat the beast. The public finally got the message. A recent paper by Jonathon Hazell of the London School of Economics and others argues that post-Volcker “changes in beliefs about the long-term monetary regime” proved more important than any other factor in conquering inflation before Covid-19. . Andrew Bailey, head of the Bank of England, has been trying to embrace the Volcker in him, for example, by giving Britons the impression that he cares more about inflation than their wages.
public enemy number one
Another solution is for politicians to get involved. This has potential drawbacks. Politicians often advocate crackpot anti-inflation schemes like price controls. Still, they might be able to help. After all, 37% of Americans believe the president has “a lot” of control over inflation, compared to 34% for the Fed. Jimmy Carter’s 1979 appointment of Volcker showed that he was serious about the reduction of inflation. In Britain, Margaret Thatcher and her minions spoke hard about price stability; her willingness to cut government budgets probably backed up those words, chilling the economy. In America today, President Joe Biden says “fighting inflation” is his “top economic priority” (although he shows less inclination to tighten fiscal policy).
Public apathy toward central banking may be a backhanded compliment to the politicians of the 1980s and 1990s. No one needed to worry about inflation when it was low. Today’s policymakers are limited by that same success. So for inflation expectations to come back down, they may need to try everything in their power to get people to sit up and listen. ■
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