Consumer inflation expectations, income changes and economic downturns

Abstract

SummaryUsing a novel, nationally representative dataset containing the expectations of over 300,000 Australians, individuals are shown to form expectations in a manner inadequately explained by popular expectation mechanisms. Approximately one in five individuals form inflation expectations that are negatively related to their own‐income changes, even after accounting for their level of optimism regarding future economic conditions and their observation of economic news. These individuals are more likely to be engaged in manual labour and to be on lower income brackets. The inflation expectations of such individuals rise, even as Phillips curve predictions of inflation fall. The findings are particularly important for inflation dynamics during economic downturns when large numbers of consumers are likely to heavily increase their inflation expectations, potentially resulting in large inflation surprises.