The Demographics of Inflation Opinion Surveys

Article excerpt

In this Commentary, we document that people report very different perceptions and predictions of inflation depending upon their income, education, age, race, and gender-a strange finding that may provide an important clue to understanding how to interpret survey data of inflation expectations.

"Price stability means that expected changes in the average price level... do not materially enter business and household financial decisions."

Federal Reserve Chairman Alan Greenspan (1989)1

Suppose your employer offers you a contract that promises a 5 percent raise next year. Would you accept? To evaluate the agreement, you need to predict next year's inflation. If you expect 6 percent inflation, you would probably decline the offer, because it means your inflationadjusted, or "real" income, will drop

I percent. But if you expect only 2 percent inflation, the 3 percent increase in your real income might be enough to persuade you to agree. In other words, economic decisions are based on the real value of things, and therefore, if economists hope to understand the behavior of the marketplace, we must see through nominal values to the "real" returns on which monetary decisions are actually made.

But an accurate gauge of inflation expectations is more than an academic interest. It is an important object of central bank policy. The potential for inflation introduces an added risk into all monetary decisions that a risk-averse public will seek to protect itself against. For example, banks will add an inflation "risk premium" into interest rate calculations, workers will negotiate "cost-of-living" provisions into their labor agreements, and investors will allocate their resources in favor of assets whose values are less sensitive to inflation erosion. All of these defensive actions involve costs that are unnecessary in a world secure from inflation. It is for this reason that the Federal Reserve's stated objective, as Chairman Greenspan's quote suggests, is about more than eliminating inflation; it is also about eliminating the expectation of inflation.

The straightforward way to judge public inflation expectations is to go out and ask people, and in fact, a few surveys do exactly that. But many economists question the reliability of survey-based measures of public inflation expectations; as a result, frustrated academics and policymakers have turned to indirect measures of the public's inflation sentiment, like the behavior of asset prices, economists' forecasts, and past inflation trends. Failure to directly assess the public's inflation expectations has left a gap in economists' ability to easily separate nominal from real values and has obscured an important variable in the deliberations of the central bank.

Three years ago, the Federal Reserve Bank of Cleveland, in association with the Ohio State University, began to investigate the inflation sentiment of Ohioans using survey data. This effort has uncovered an intriguing result. Survey-based estimates of inflation sentiment are dramatically and systematically influenced by the demographic characteristics of the respondent. Income, education, age, race, and gender are all strongly correlated with respondents' perceptions of inflation and their forecast of future inflation. We believe this finding provides an important clue in understanding inflation opinion surveys.

* And the Survey Says...

Why aren't surveys of the public's inflation expectations taken more seriously? The problem is that if you simply ask people what course they expect inflation to take, the average response does not track the realized inflation data very closely.

Some researchers have found that people repeatedly make the same errors in their inflation predictions, often expecting inflation to be higher than it turns out to be. And others find that people appear to ignore readily available information that would help improve the accuracy of their forecasts. …