Inflation has recently surged in both the US and the EU. In November 2021, the inflation rate in the US was 6.8%, the highest annual increase in inflation since June 1982. In November 2021, inflation across the 19-member euro area was 4.9%, the highest since the euro was introduced. There is currently a large debate about whether the rise in inflation will be transitory or persistent (Goodhard and Pradhan 2021), and many economists and policymakers worry about a potential de-anchoring of inflation expectations among firms and households (Corsello et al. 2019). Given that inflation expectations are an important determinant of future inflation (Reis 2021a, 2021b), it is important to understand how households and firms interpret the recent surge in inflation and whether they expect it to be transitory or persistent.
Experts who debate whether the current surge in inflation is transitory or persistent tend to offer different explanations for the surge in inflation. Some economists, such as Paul Krugman, have argued in favour of a transitory view and tend to explain the surge in inflation by pent-up demand associated with the end of lockdowns or temporary supply issues (Krugman 2021). Other economists active in the public debate, such as Larry Summers, argue that inflation is likely to be persistent (Summers 2021). Which narrative experts and households follow to make sense of the surge in inflation might thus have important implications for how persistent they expect inflation to be. For instance, if households associate the surge in inflation with temporary factors, such as pent-up demand after the end of lockdowns, de-anchoring of long-term inflation expectations seems less likely than if they associate it with more structural changes in the labour market or a shift in central bank priorities towards looser policies.
Large-scale surveys on inflation narratives
In a new paper (Andre et al. 2021), we analyse surveys conducted in November 2021 with a broadly representative sample of the US population as well as with samples of academic economists and US firm managers. In the surveys, we measure the stories that people tell about the causal drivers of the surge in inflation with open-ended text questions. Specifically, we ask respondents to explain which factors they think caused the increase in the inflation rate. These open-ended responses offer a lens into people’s spontaneous thoughts about inflation without priming them on any particular issue or factor driving the increase in inflation.
To illustrate how people reason about inflation, we first provide some representative survey responses among both experts and households. Experts' responses focus on a combination of supply- and demand-side mechanisms and are usually quite rich and complex in nature. For example, the following expert mentions both supply chain disruptions and pent-up demand:
“Supply chain issues are probably the most important factor. Pent up demand from the pandemic, combined with historically high household savings/wealth, which has made consumers less price-sensitive, is probably the second most important factor. This has allowed firms to increase prices without losing customers.”
Moreover, many experts also emphasise the role of fiscal stimulus programs in conjunction with supply-side disruptions:
“The inflation was caused by an aggregate stimulus of unprecedented size in the face of persistent supply constraints whose severity was not anticipated by policy-makers.”
Some experts focus on only one particular driver of inflation. For example, the following expert emphasises the role of monetary policy:
“Money printing (cheap Fed rates and quantitative easing). Inflation is a monetary phenomenon and will always be so.”
The explanations households provide more often focus on one particular factor, such as fiscal stimulus programs. As one household respondent writes:
“The fact the government handed 'free' money like it was candy, we are all now paying for that free money they gave us.”
Moreover, many households use narratives that are absent in economics textbooks but have arguably been widely covered in the mainstream media:
“[...] I'm sure business owners are just trying to recoup monies lost during the last year by raising their prices. [...]”
Many narratives among households are also politically tainted. For example, some respondents tell a story of an incompetent US government causing the rise in inflation:
“I think having Biden as president caused all of the inflation and it’s going to get a lot worse.”
To analyse the open-ended responses in a structured way, we hand-code each response according to a coding scheme that includes the most prominent theoretical explanations for the surge in inflation as well as a series of explanations that are not typically captured in economic theories, but which are commonly mentioned by households. The codes refer to a set of demand-side drivers of inflation (such as pent-up demand associated with the end of lockdowns), supply-side drivers of inflation (such as the disruption of global supply chains), and a set of other factors (such as politics or expectations).
As shown in Figure 1, there is substantial heterogeneity in how households, experts, and firm managers explain higher inflation rates. The three most common explanations cited by experts relate to supply chain issues (55%), government spending (46%), and monetary policy (37%). Experts thus tend to focus on textbook explanations related to higher production costs or higher demand. Households, by contrast, tend to put less emphasis on demand-side explanation and are relatively more likely to emphasise supply chain issues and generic narratives related to the pandemic or political issues. The three most cited explanations by households are labour shortages (26%), supply chain issues (25%), and politics (24%). Managers tend to provide stories more similar to households than academic experts and are most likely to emphasize labour shortages (22%), supply chain issues (22%), and generic references to corona (19%) to explain the rise in inflation.
Relative to experts, households and firm managers more often provide generic, politicised narratives related to the pandemic or government mistakes. The prevalence of politically tainted narratives illustrates how politicised the debate about inflation is. Many households blame the government for the surge in inflation, especially Republicans. Furthermore, in contrast to experts, many households attribute the rise of inflation to corporate greed and price gouging.
Figure 1 Inflation narratives across samples
After eliciting narratives, we measure short-run and medium-run inflation expectations. As shown in Figure 2, households and managers are more likely than experts to think that the current surge in inflation will be persistent. Experts predict an inflation rate of 3.7% over the next 12 months, compared to 4.1% among managers and 4.7% among households. For the five-year-ahead forecast, experts predict an inflation rate of 2.6%, while managers and households expect inflation rates of 3.4% and 3.9%, respectively.
Figure 2 Inflation expectations across samples
As shown in Figure 3, the stories people tell about why inflation has increased are strongly predictive about their future inflation expectations. For example, households mentioning energy shortages or government mismanagement as drivers of the surge in inflation have significantly higher one-year and five-year inflation expectations. Households mentioning expansionary monetary or fiscal policy also expect significantly higher inflation in the short term and somewhat higher inflation in the long term.
Figure 3 Inflation narratives and inflation expectations
The prevalence of rich and diverse narratives about the macroeconomy has important implications for understanding and modelling expectation formation (Coibion et al. 2019, 2021, van der Cruijsen et al. 2015, Reichlin 2021, Stanisławska and Paloviita 2021). In particular, our findings suggest that there is vast heterogeneity in the narratives individuals use to explain observed economic phenomena. This heterogeneity in turn is associated with differences in expectations about macroeconomic developments in the future. Thus, heterogeneity in narratives about the economy seems to contribute to the widely documented disagreement in macroeconomic expectations among households, firms, and professional forecasters (Coibion and Gorodnichenko 2012, Coibion et al. 2018, Dovern et al. 2012, Giglio et al. 2019). Our results also have implications for monetary policymaking. Specifically, the narratives individuals use to explain movements in inflation seem to be central to whether their inflation expectations remain anchored. Thus, communication strategies could put emphasis on specific narratives that highlight that inflationary pressures are unlikely to persist.
Andre, P, I Haaland, C Roth, and J Wohlfart (2021), “Inflation narratives”, CEPR Discussion Paper 16758.
Coibion, O and Y Gorodnichenko (2012), “What can survey forecasts tell us about information rigidities?”, Journal of Political Economy 120(1): 116-159.
Coibion, O, Y Gorodnichenko, and S Kumar (2018), “How do firms form their expectations? New survey evidence”, American Economic Review 108(9): 2671-2713.
Coibion, O, Y Gorodnichenko, and M Weber (2019), “Monetary policy communications and their effects on household inflation expectations”, VoxEU.org, 22 February.
Coibion, O, Y Gorodnichenko, and M Weber (2021), “How inflation expectations affect households’ spending decisions”, VoxEU.org, 19 March.
Corsello, F, S Neri, and A Tagliabracci (2019), “Anchored or de-anchored? That is the question”, VoxEU.org, 05 November.
Dovern, J, U Fritsche, and J Slacalek (2012), “Disagreement among forecasters in G7 countries”, Review of Economics and Statistics 94(4): 1081-1096.
Giglio, S, M Maggiori, J Stroebel, and S P Utkus (2019). “Heterogeneity everywhere: Survey beliefs and portfolio allocations”, VoxEU.org, 02 August 2019.
Goodhart, C and M Pradhan (2021), “What may happen when central banks wake up to more persistent inflation?”, VoxEU.org, 25 October.
Krugman, P (2021), “History says don’t panic About inflation”, New York Times, November 11.
Reichlin, L, K Adam, W J McKibbin, M McMahon, R Reis, G Ricco, and B Weder Di Mauro (2021), “The ECB strategy: The 2021 review and its future”, VoxEU.org, 1 September.
Reis, R (2021a), “Losing the inflation anchor”, Brookings Papers on Economic Activity, London School of Economics and Political Science.
Reis, R (2021b), “Does anyone actually understand inflation?”, The Economist, 9 October.
Stanisławska, E and Paloviita, M (2021), “How euro area consumers adjust their medium-term inflation expectations in turbulent times”, VoxEU.org, 26 November.
Summers, L (2021), “On inflation, it’s past time for team ‘transitory’ to stand down”, The Washington Post, November 15.
van der Cruijsen, C, D-J Jansen, and J de Haan (2015), “What the general public knows about monetary policy”, VoxEU.org, 23 August.