When prices started soaring in 2022 in the aftermath of the Covid-19 pandemic, many people worried that we were heading back to the chaotic economic experiences of the 1970s. In particular, central banks became concerned that a situation would emerge in which the public stopped believing that inflation would eventually return to the normal low levels to which they had become accustomed.
In a recent study, we use a new method to look into the minds of economic experts to see if their long-term trust in the economy was actually broken. We find that while people were shocked by the size of the price increases, they still believed that the effects would be short-lived.
Measuring what people believe about economic surprises
We have developed a new way to measure what people believe about economic surprises and how long those surprises will affect the economy. We look at how professional forecasters change their minds about inflation over different timeframes – from the next few months to ten years away. By exploring these shifts, our study identifies one main ‘shock’ or surprise that drives most of the changes in people’s beliefs.
Most importantly, we show that beliefs about inflation have changed over the last 40 years. In the 1980s, if inflation went up, people expected it to stay high for a long time. Today, people view these surprises as temporary spikes. This suggests that expectations have become ‘anchored’, meaning that we have more faith that inflation will eventually settle down.
A tool for seeing how beliefs change over time
Our research helps us to understand the difference between an economy that has lost its way and one experiencing a massive but temporary event.
In 2022, long-term inflation expectations rose sharply. Some thought this meant that people had lost faith in the ability of the Federal Reserve (the US central bank) to control prices. But our study shows that the 2022 jump was mostly caused by the sheer size of the surprise, not by a belief that high inflation was here to stay.
Our study provides a more reliable tool for seeing how beliefs change over time by focusing on how people update their forecasts (revisions) rather than just looking at the predictions themselves (levels).
Older methods often try to model the exact level of people’s expectations, which can force a rigid and artificial structure onto the data. By directly examining how these views change from month to month, our method is more flexible and robust. This allows policy-makers to see exactly when and how people are losing or gaining trust in the economy.
Understanding the human stories behind the data
Our tool can be used for much more than just measuring inflation. It could be applied to individuals rather than just groups to see how different people react to economic news. This could help us to understand why some groups are more worried about the future than others.
In addition, future research could combine expectations for different indicators, such as prices and the total output of the economy. This would help us to figure out if people think a price spike is being caused by a lack of goods (a supply problem) or by too much money being spent (a demand problem). Understanding these ‘human stories’ behind the data will help governments to make better decisions during the next crisis.
