Academic journal article The Journal of Consumer Affairs

Expectations of Inflation: The Role of Demographic Variables, Expectation Formation, and Financial Literacy

Academic journal article The Journal of Consumer Affairs

Expectations of Inflation: The Role of Demographic Variables, Expectation Formation, and Financial Literacy

Article excerpt

When financial decisions have consequences beyond the immediate future, individuals' economic success may depend on their ability to forecast the rate of inflation. Higher inflation expectations have been reported by individuals who are female, poorer, single and less educated. Our results suggest that these demographic differences in inflation expectations may be partially explained by variations in expectation formation and financial literacy. Specifically, higher inflation expectations were reported by individuals who focused more on how to cover their future expenses and on prices they pay (rather than on the US inflation rate) and by individuals with lower financial literacy.

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In the course of everyday life, people make a variety of financial decisions about saving, investing and borrowing, among other things. When their effects extend into the future, financial decisions require accurate assessments of inflation rates. Inflation expectations have been studied by economists, psychologists, marketing scientists and others concerned about individuals' financial wellbeing and the impacts of their choices on the economy. Indeed, individuals' perceptions and expectations of inflation may affect actual realized inflation and other economy-wide outcomes (Katona 1975). A better understanding of these inflation expectations can help economists and central bankers to improve their forecasts of future macroeconomic trends and formulate monetary policy.

Indirect measures of public inflation expectations have been derived from the behavior of prices for inflation-indexed securities, economists' forecasts and past inflation trends. Although complex inferences are needed to derive inflation expectations from these measures, surveys can be used to directly elicit people's inflation expectations (Blanchflower and Coille 2009; Bryan and Venkatu 2001b, Curtin 1996; Jonung 1981; Ranyard et al. 2008). Median responses in these surveys sometimes outperform professional and model-based forecasts in predicting actual inflation (Ang, Bekaert, and Wei 2007; Hafer and Hein 1985; Thomas 1999). However, some demographic groups report systematically higher, and seemingly unrealistic, inflation expectations. Those groups include individuals who report less income and no college education, as well as those who are single, female and belong to racial and ethnic minorities (Bryan and Venkatu 2001a, 2001b; Jonung 1981). Reported relationships between age and inflation expectations have been inconsistent, with some studies finding higher inflation expectations among younger respondents (Bryan and Venkatu 2001b; Jonung 1981) and others finding higher expectations among older respondents (Blanchflower and Coille 2009; Lombardelli and Saleheen 2003). Studies using regression models controlling for interrelationships between demographic variables suggest that inflation expectations are mostly driven by older age and measures of lower socio-economic status such as reporting less education, less income and living in public housing (Blanchflower and Coille 2009; Lombardelli and Saleheen 2003).

One explanation proposed for demographic differences in reported inflation expectations is that individuals from population groups who report higher inflation expectations also experience a relatively higher rate of inflation in their actual consumption. For example, the elderly may experience a higher rate of inflation due to their health care expenditures (Hobijn and Lagakos 2003; McGranahan and Paulson 2006). However, even though the rate of inflation varies widely across product categories, (1) actual inflation experiences of individual households do not seem to vary much. For example, Hobijn et al. (2009) reported that between 1995 and 2005, annual inflation rates experienced varied by only .2% to .4% across different demographic groups (see also Kokosi 2000).

Here, we considered three possible explanations for demographic differences in inflation expectations. …

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