Managing Households’ Expectations with Simple Economic Policies

Abstract

Managing households’ expectations directly is a novel policy tool to stimulate the economy by lowering the incentives to save, but so far policies based on this idea have been barely effective. We argue that simplicity is a crucial and yet neglected feature of effective policies that target households instead of financial-market participants. We illustrate this point using novel micro data for a representative population to compare households’ reactions to unconventional fiscal policy and forward guidance announcements. Both policies aim to stimulate consumption via raising households’ inflation expectations, but to understand the implications of forward guidance households need sophistication in economic theory, which is not true for unconventional fiscal policy. Consistent with our conjecture, households’ inflation expectations, consumption, and saving propensities react substantially to unconventional fiscal policy announcements, irrespective of households’ sophistication. Instead, households’ expectations, contrary to those of financial market participants, do not react to forward guidance announcements and hence households’ choices do not react either. Our results inform theorists and policy makers on a neglected dimension to assess the channels of transmission of policies targeting households — simplicity.