Discussion paper

DP17356 Low Passthrough from Inflation Expectations to Income Growth Expectations: Why People Dislike Inflation

Using a novel experimental setup, we study the direction of causality between consumers' inflation expectations and their income growth expectations. In a large, nationally representative survey of US consumers, we find that the rate of passthrough from expected inflation to expected income growth is incomplete, on the order of 20 percent. There is no statistically significant effect going in the other direction. Passthrough varies systematically with demographic and socioeconomic factors, with greater passthrough for higher-income individuals than lower-income individuals, although it is still incomplete. Higher inflation expectations also cause consumers to report a higher probability that they will search for a new job that pays more. Using our survey findings to calibrate a search-and-matching model, we find that dampened responses of real wages to demand and supply shocks translate into greater fluctuations in output. Taken together, the survey results and model exercises provide a labor market channel to explain why people dislike inflation.

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Citation

Hajdini, I, E Knotek, J Leer, M Pedemonte, R Rich and R Schoenle (eds) (2022), “DP17356 Low Passthrough from Inflation Expectations to Income Growth Expectations: Why People Dislike Inflation”, CEPR Press Discussion Paper No. 17356. https://cepr.org/publications/dp17356-0