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Do Actions Speak Louder Than Words? Household Expectations of Inflation Based on Micro Consumption Data

Authors


  • We thank the editor and two anonymous referees. We also have benefited from discussions with Jason Allen, Chris House, Matthew Shapiro, Mark Watson, and Jonathan Wright. Atsushi Inoue acknowledges financial support from the North Carolina Agricultural Research Service under project NC 02265.

Abstract

Survey data on household expectations of inflation are routinely used in economic analysis, yet it is not clear how accurately households are able to articulate their expectations in survey interviews. We propose an alternative approach to recovering households' expectations of inflation from their consumption expenditures. We show that these expectations measures have predictive power for consumer price index (CPI) inflation. They are better predictors of CPI inflation than household survey responses and more highly correlated with professional inflation forecasts, except for highly educated consumers, consistent with the view that more educated consumers are better able to articulate their expectations. We also document that households' inflation expectations respond to inflation news, as measured by the unpredictable component of inflation predictions in the Survey of Professional Forecasters. The response to inflation news tends to increase with households' level of education, consistent with the existence of constraints on household's ability to process this information.

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