Memory, experiences, and inflation expectations

How memory cues shape inflation beliefs

Gennaioli et al., in this paper, present a model of inflation expectations based on selective memory and test its predictions using survey data. The authors develop a model where people form inflation expectations by selectively recalling past inflation experiences based on:

1. The frequency of experienced inflation levels
2. Temporal context (recency and primacy effects)
3. Numerical similarity to current inflation and the inflation scenario being evaluated

They test the model’s predictions using microdata from two surveys:  the University of Michigan’s Survey of Consumers (MSC) and the  Federal Reserve Bank of New York’s Survey of Consumer Expectations (SCE).

Their key findings include:

• Selective memory mechanisms significantly influence inflation expectations: People who experienced higher average inflation report higher expectations. Both early-life experiences and recency effects are observed even though people overweight past experiences similar to current inflation.
• The model explains the sharp de-anchoring of inflation expectations in 2021. In particular, it accounts for why elderly people’s expectations rose more sharply than younger people’s.
• Out-of-sample nowcasting: The model successfully predicts the re-anchoring of expectations as inflation fell in 2022-2024.
• Quantitative importance: A one standard deviation increase in similarity based recall measures decreases inflation expectations by 0.18-0.29 percentage points.

Gennaioli et al. conclude that memory-based models, emphasizing similarity, frequency, and interference, offer a promising approach to studying belief formation in macroeconomics and finance.

How Inflation Expectations Dis-Anchor: the Role of Selective Memory Cues
Authors: Nicola Gennaioli, Marta Leva, Raphael Schoenle, Andrei Shleifer
From: Bocconi University, Brandeis University, Harvard University

Household shocks and inflation beliefs

Butera et al. in this paper examine how household-level events influence people’s beliefs about the economy, particularly inflation forecasts and backcasts. The authors link Danish Consumer Expectations Survey data (2012-2019) with administrative tax, health, and other registry data. Survey respondents were aged 25-60 but respondents with significant self-employment income were excluded. Finally, the authors constructed measures of recent and future household income changes using tax data and utilized emergency room (ER) visit data as a proxy for negative household events.

Key findings:

Inflation forecasts are strongly negatively associated with:

• Recent household income changes
• Expected future income changes (survey-based)
• Realized future income changes
• These associations violate rational expectations, as actual inflation shows no relationship with these variables

Role of Memory and Affect

• Inflation backcasts (perceptions of past inflation) show even stronger associations with income changes than forecasts
• ER visits in the survey month significantly increase both inflation forecasts and backcasts
• The effect of ER visits is larger for backcasts than forecasts

Mechanism

• Results suggest associative memory plays an important role in belief formation
• Positive (negative) household events cue recall of positive (negative) experiences, influencing inflation beliefs
• Even unrelated negative events (ER visits) impact inflation perceptions

The authors conclude that these findings challenge theories of limited-information rational expectations and suggest that “experience effects” may reflect a broader psychology where events in one domain influence beliefs in unrelated domains.

Beliefs About the Economy are Excessively Sensitive to Household-Level Shocks: Evidence from Linked Survey and Administrative Data
Authors: Luigi Butera, Chen Lian, Matteo Saccarola, Dmitry Taubinsky
From: Copenhagen Business School, University of California-Berkeley

Similar research on inflation expectations formation can also be found in two recent newsletters:

On experience-based inflation expectations (June 4, 2024)
Public perceptions of inflation (September 19, 2024)

For a quick exploration of this research, we invite you to listen to our accompanying podcast. This audio format offers a narrative that highlights the key insights and findings of all the studies included in the three newsletters.
14 minute podcast