This morning the WSJ reported that “Consumers expect to see inflation of 4.1% a year from now, the lowest such reading in two years and down sharply from its recent peak of 6.8%.”
Some think it’s good news, but like us highlighted in May, it is a meaningless and offbeat investigation. In fact, it may even be worse than that, as it seems that some at the Federal Reserve actually believe the Fed’s own consumer survey contains information. As we have shown previously (repeatedly), this is not the case.
At least it doesn’t contain valuable information giving insight into future inflation levels. What it reveals is that the Federal Reserve is unaware of the latest research on 1) what drives inflation; 2) The fallibility of surveys and polls; 3) An up-to-date understanding of behavioral economics and how human decision-making works.
The last time we noted, Sentiment surveys are generally unnecessary; their most treasured moments occur at extremes, which are usually visible in hindsight. People don’t have the ability to predict things like what inflation will be like in 1, 3 or 5 years. They can (arguably) extrapolate the current CPI over a few months or quarters, but even that might be too generous. And while people’s expectations can factor into inflation, it’s just one of many, and one that’s easily changed.
As the Fred the chart below shows that consumers were quite optimistic about inflation at the start of its huge acceleration in 2021; they were freaked out by inflation at the top, just as it was beginning to collapse. If you bought inflation futures based on consumer expectations, you would quickly go broke.
To say that it is a useful measure reveals an irrational attachment to an outdated norm. As Brooking explained, it dates back to the late 1960s work of Nobel laureates Edmond Phelps And Milton Friedman. They focused on inflation expectations because of the links between inflation and unemployment. The persistence of high inflation in the 1970s is no longer entrenched, as long-lasting inflation led to higher wage demands. The wage-price spiral phenomenon continued in the 1970s and 1980s.
It still seems to linger among some economists, who ignored what happened after the post-pandemic/post-fiscal stimulus: despite the rise in the CPI, unemployment continued to fall.
Consider what has happened since the 1970s: globalization has increased, automation has become widespread, and productivity has increased dramatically. I suspect that these factors partly explain why inflation and unemployment have decoupled. The other part is that the economy is so different today than it was 50 years ago, that using a 1970s analogue is a recipe for failure.
The whole concept of the efficient market hypothesis (which won the Nobel Prize for Eugene Fama) was that what people say about anything is worth far less than what they do, especially with their hard-earned money. Whether they invest it in the market or buy inflated consumer goods is in itself a valuable source of information; certainly much better than asking them what they thought inflation might be in the distant future.
People who should know better pay way too much attention to inflation expectations. The charts above show that they shouldn’t…
Inflation expectations are useless (May 17, 2023)
The transient is taking longer than expected (February 10, 2022)
nobody knows anything (May 5, 2016)
What news looks like when it’s old (October 29, 2021)
Good news for the Fed: Buyers see lower inflation on the horizon
By Christian Robles
WSJ, July 3, 2023