Inflation Expectations and Readiness to Spend: Cross-Sectional Evidence / Rüdiger Bachmann, Tim O. Berg, Eric R. Sims.

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Bachmann, Rüdiger

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TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w17958.Publication details: Cambridge, Mass. National Bureau of Economic Research 2012.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: There have recently been suggestions for monetary policy to engineer higher inflation expectations so as to stimulate current spending. But what is the empirical relationship between inflation expectations and spending? We use the underlying micro data from the Michigan Survey of Consumers to test whether increased inflation expectations are indeed associated with greater reported readiness to spend. Cross-sectional data deliver the necessary variation to test whether the relationship between inflation expectations and spending changes in the recent zero lower bound regime compared to normal times, as suggested by many standard models. We find that the impact of inflation expectations on the reported readiness to spend on durable goods is statistically insignificant and small in absolute value when compared to other variables, such as household income or expected business conditions. Moreover, it appears that higher expected price changes have an adverse impact on the reported readiness to spend. A one percent increase in expected inflation reduces the probability that households have a positive attitude towards spending by about 0.1 percentage points. At the zero lower bound this small adverse effect remains, and is, if anything, slightly stronger. We also extend our analysis to the reported readiness to spend on cars and houses and obtain similar results. Altogether our results tell a cautionary tale for monetary (or fiscal) policy designed to engineer inflation expectations in order to generate greater current spending.

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March 2012.

There have recently been suggestions for monetary policy to engineer higher inflation expectations so as to stimulate current spending. But what is the empirical relationship between inflation expectations and spending? We use the underlying micro data from the Michigan Survey of Consumers to test whether increased inflation expectations are indeed associated with greater reported readiness to spend. Cross-sectional data deliver the necessary variation to test whether the relationship between inflation expectations and spending changes in the recent zero lower bound regime compared to normal times, as suggested by many standard models. We find that the impact of inflation expectations on the reported readiness to spend on durable goods is statistically insignificant and small in absolute value when compared to other variables, such as household income or expected business conditions. Moreover, it appears that higher expected price changes have an adverse impact on the reported readiness to spend. A one percent increase in expected inflation reduces the probability that households have a positive attitude towards spending by about 0.1 percentage points. At the zero lower bound this small adverse effect remains, and is, if anything, slightly stronger. We also extend our analysis to the reported readiness to spend on cars and houses and obtain similar results. Altogether our results tell a cautionary tale for monetary (or fiscal) policy designed to engineer inflation expectations in order to generate greater current spending.