We review three papers on inflation expectations. The first paper (“How Inflation Expectations De-Anchor: The Role of Selective Memory Cues” by Gennaioli et al. (2024)) develops a model and argues that selective memory recall can explain why (short-term) inflation expectations, especially among older individuals, de-anchor rapidly in response to inflation surges. The second paper (“Inflation (de-)anchoring in the Euro Area” by Burban et al. (2024)), explores the stability of inflation expectations in the Euro area using a no-arbitrage term structure model. The final paper (“People’s Understanding of Inflation” by Binetti et al. (2024)) explores how the general public perceives inflation and finds that the public’s understanding of inflation often diverges from established economic theories.
Paper #1: Gennaioli et al. (2024)
“How Inflation Expectations De-Anchor: The Role of Selective Memory Cues” by Nicola Gennaioli (Bocconi), Marta Leva (Bocconi), Raphael Schoenle (Brandeis), and Andrei Shleifer (Harvard) explores the cognitive mechanisms behind how inflation expectations become unstable during periods of high inflation. The study argues that selective memory recall can explain why inflation expectations, especially among older individuals, de-anchor rapidly in response to inflation surges. Such similarity-based recall of past inflation experiences can account for the sharp rise in (short-term) inflation expectations following the pandemic, particularly among the elderly.
What the paper does and main results
The paper provides a psychology-based explanation for why inflation expectations become unstable, or de-anchored, when inflation rises sharply. Traditional macroeconomic models assume inflation expectations are anchored by past experiences and adjust gradually. However, during the inflation surge in 2021-2022, expectations (at least short-term ones) rose across all age groups, with older individuals exhibiting the sharpest response, contrary to standard expectations (see Figure 1). The elderly, having lived through past periods of high inflation (e.g., the 1970s), are more likely to recall those experiences when inflation rises again, causing a sharp upward revision in their expectations. The authors propose a new memory-based model to explain this pattern.
The model generates several key predictions, which the authors confirm in the data. Using data from the University of Michigan’s Survey of Consumers (MSC) and the Federal Reserve Bank of New York’s Survey of Consumer Expectations (SCE), the authors show that selective memory recall can explain the sharp rise in inflation expectations post-pandemic, especially among older individuals. The authors also show that people’s estimates of inflation probabilities are influenced by how similar current inflation is to their past experiences, leading to higher probabilities for ranges they are more familiar with.
Figure 1. Inflation expectations (left) and experienced inflation (right) by age cohorts. Green refers to youngest cohort, red to oldest. Age cohorts differ across panels.
A critique of the paper
The paper provides an innovative approach to understanding how inflation expectations are formed, particularly in periods of high inflation. The use of a memory-based model introduces a fresh perspective on the cognitive mechanisms that drive belief formation. The paper’s results can therefore be used as a micro foundation to inform reduced-form representations in macroeconomic models. By integrating cognitive psychology into macroeconomic modeling, the authors move beyond the traditional frameworks that represent inflation expectations via simple backward-looking rules.
However, simple backward-looking descriptions of expectation formation may explain much of what the paper is trying to answer. A quick inspection of Figure 1, used to motivate the paper, suggests that inflation expectations rose very closely with experienced inflation, that higher inflation expectations among the elderly coincided with higher experienced inflation, and that the change in inflation expectations across age cohorts had the same speed. It is therefore unclear if selective memory recall is necessary to explain these phenomena, a question that remains open since the authors’ regressions do not control for lagged experienced inflation rates.
Paper #2: Burban, De Backer, and Vladu (2024)
“Inflation (de-)anchoring in the Euro Area” by Valentin Burban (Banque de France), Bruno De Backer (National Bank of Belgium), and Andreea Liliana Vladu (ECB), explores the stability of inflation expectations in the Euro area, particularly in relation to the European Central Bank’s inflation target. Using a no-arbitrage term structure model that allows for a time-varying long-term mean of inflation expectations, the authors analyze inflation-linked swap (ILS) rates to measure potential de-anchoring of inflation expectations. Long-term inflation expectations in the Euro area have remained broadly anchored, with small signs of de-anchoring observed at shorter horizons.
What the paper does and main results
The paper employs a no-arbitrage affine term structure model to infer inflation expectations from inflation-linked swap (ILS) rates. The ILS data is available from June 2005 until December 2023. The term-structure model features time-varying long-term inflation expectations. The model uses data from the ECB’s Survey of Professional Forecasters and the Consensus Economics survey to anchor the estimation of the expectations component using various forward ILS rates. These rates are dissected to evaluate short-, medium-, and long-term inflation expectations.
Inflation expectations have generally remained well anchored close to the ECB’s target of 2%, with few signs of de-anchoring. Figure 2 shows that short-term inflation expectations had increased markedly during the Covid period but then quickly returned to target (top-left panel), while medium-term expectations are hovering slightly above target. Additional results show that long-term expectations have remained very stable and close to 2% over the entire sample period.
Figure 2. Decomposition of ILS rates (blue line) into expectation (red) and risk premium (yellow) component, for different maturities.
A critique of the paper
The paper provides a useful attempt at disentangling interest rate swaps into inflation expectations and risk premia. However, it is unclear what the obtained expectations measures tell us. Plenty of measures of inflation expectations are already available, and the authors do little to convince us that their new measure more accurately captures the relevant notion of expectations that we would want to use in a Phillips curve framework or other models. While findings of little to no dis-anchoring therefore confirm existing findings, the contribution from an economic perspective appears small.
Paper #3: Binetti, Nuzzi, and Stantcheva (2024)
“People’s Understanding of Inflation” by Alberto Binetti (Bocconi University), Francesco Nuzzi (Harvard), and Stefanie Stantcheva (Harvard) explores how the general public perceives inflation—its causes, consequences, and appropriate policy responses. Based on a large-scale online survey with experimental components, the authors find that the public’s understanding of inflation often diverges from established economic theories. Respondents largely attribute inflation to government actions and production costs, perceive it as an unambiguously negative phenomenon, and demonstrate significant resistance to traditional anti-inflationary policies like monetary tightening.
What the paper does and main results
The study uses a detailed online survey among a representative sample of the U.S. population to explore beliefs about the causes and consequences of inflation, as well as preferred policy responses. The most commonly perceived causes of inflation include government actions such as increased foreign aid and war-related expenditures, as well as rising production costs linked to events like the COVID-19 pandemic and supply chain disruptions. There is a strong partisan divide in these perceptions, with Republicans more likely to blame government policies and Democrats more likely to attribute inflation to corporate actions. Inflation is perceived to increase complexity of household decision-making, causing widespread economic uncertainty and complicating daily financial choices. Respondents believe that inflation disproportionately harms lower-income households, exacerbating inequality.
Respondents show little support for monetary tightening, with many respondents mistakenly believing that raising interest rates would increase inflation. Figure 3 shows that 50% of respondents favor interest rate decreases, with less than 20% favoring increases. Respondents are also unaware of the typical trade-offs between inflation and economic activity faced by central banks. Instead, there is a preference for policies perceived to have broader benefits, such as increasing corporate taxes or reducing government debt through progressive taxation. An information experiment, which aimed to correct misconceptions and explain the trade-offs involved in anti-inflationary policies, had limited success in changing these entrenched views.
Figure 3. Respondent views on monetary policy decisions to combat inflation. Blue bars are responses by Democrats, red by Republicans.
A critique of the paper
Perceptions of the optimal policy response could depend on the financial position of the household and need not be irrational. While higher interest rates are generally the main monetary tool to address inflation on aggregate, individual households may face an additional financial burden from higher rates via their mortgages or other debt payments (as argued here) and suffer income losses from a slowdown in economic activity, possibly explaining their preference for rate cuts.
Policy implications
The widespread resistance to traditional monetary policy measures, such as interest rate hikes, suggests that central banks may face public pushback when attempting to combat inflation through these tools. This resistance could complicate the implementation of effective monetary policy, particularly if policymakers do not address the public’s misconceptions about the relationship between interest rates and inflation. The preference for policies that target corporations or redistribute wealth indicates a public appetite for measures that go beyond traditional macroeconomic tools. Policymakers might need to consider integrating these preferences into a broader strategy for managing inflation, particularly in ways that address the public’s concerns about inequality and economic fairness, without endangering the effectiveness of their traditional tools.
The paper highlights the importance of improving public understanding of economic trade-offs. Given the limited success of the information experiment conducted in the study, future efforts to educate the public on inflation may need to adopt more sophisticated and sustained approaches, possibly involving collaboration between economists, educators, and the media to better communicate the complexities of inflation and its management. The findings also suggest that information campaigns as currently conducted by central banks like the ECB and the use of easier language to address a wider audience may not be efficient in educating the public, while creating unnecessary ambiguities and market volatility from the use of less technical language in press conferences.