Since 2009, the Federal Reserve has regularly announced its inflation targets, effectively telling the world whether prices for US goods will be higher or lower in the future. Such openness is necessary, the Fed has explained, to influence constituents’ spending decisions as a means to benefit the broader economy.
The public, however, has not gotten the message. Many Americans still exhibit a profound lack of awareness about inflation and the policies meant to guide it, according to research by University of Texas at Austin’s Olivier Coibion, University of California at Berkeley’s Yuriy Gorodnichenko, and Chicago Booth’s Michael Weber.
The study relies on a survey of about 83,000 households, the Chicago Booth Expectations and Communication Survey, created in cooperation with Nielsen. Its design and participants mirror the closely watched University of Michigan Surveys of Consumers and the New York Fed Survey of Consumer Expectations.
Almost 40 percent of the respondents in the Chicago Booth survey estimated the Fed’s inflation target at 10 percent or more, a level high enough to call a crisis in most developed countries. (The Fed’s inflation target is 2 percent, and inflation has averaged around 2 percent over the past two decades.) Barely half of respondents gave a number between 0 and 5 percent.
Why are so many people grossly misinterpreting the Fed’s intentions?
The researchers find that how the Fed distributes its messages plays a key role in how the public responds. They argue that the Fed could dramatically influence household inflation expectations with simpler messages, such as a single sentence stating its inflation forecast, delivered directly to consumers. But when Fed announcements are filtered through popular media—the way most Americans hear from the institution now—those messages do little to change minds, the study finds. Moreover, should the Fed move its messaging to Twitter? The researchers also find most Americans no longer read traditional newspaper articles and instead consider social media a credible source of news about the economy.
With each of the Federal Open Market Committee’s eight annual meetings, the Fed issues a wordy statement that includes its new, or unchanged, federal funds rate and its inflation target. The announcement explains the reasoning behind the numbers, often using standard industry phrases such as “risks to the economic outlook appear roughly balanced” and “the stance of monetary policy remains accommodative.”
While anyone can read FOMC announcements online, the US government traditionally relies on the popular press to turn this notorious Fed speak into digestible public-service messages. For example, USA Today’s translation of the Fed’s statement describing its “balanced” and “accommodative” monetary policy read: “Citing a brighter economic outlook, the Federal Reserve raised its key short-term interest rate Wednesday but maintained its forecast for a total of three hikes this year amid still-modest inflation.” The article further explains that the federal funds rate rose to 1.75 percent from 1.5 percent, and that the change would increase interest rates for credit cards, mortgages, and other loans.
The Chicago Booth survey, given in May/June, September, and December 2018, asked participants to state the rate of inflation for the past 12 months and to predict the level of inflation for the following 12 months. Respondents also estimated the Fed’s inflation goals and provided their own expectations about unemployment.
After decades of purposely ambiguous public announcements, the US Federal Reserve began incorporating specifics into its forward guidance in response to the 2008–09 financial crisis.
A. LANGUAGE SUBTLETIES: Having previously stated that people could expect an “exceptionally low” federal funds rate “for some time,” the Fed says it would likely stay exceptionally low “for an extended period.” (March 2009)
B. SPECIFIC DATES: The Fed says the rate will stay exceptionally low “at least through mid-2013.” (August 2011)
C. DATA THRESHOLDS: The Fed says the rate will stay below 0.25 percent “at least as long as the unemployment rate remains above 6-1/2 percent” and inflation projections are no more than “a half percentage point above” the Fed’s longer run goal of 2 percent. (December 2012)
D. EARLY WARNINGS: The Fed says “it can be patient in beginning to normalize the stance of monetary policy.” (December 2014)
E. CALMING WORDS: Raising the target range for the first time since before the 2008–09 financial crisis, the Fed says it expects “only gradual increases in the federal funds rate.” (December 2015)
F. DELIBERATE OMISSIONS: Dropping a reference to further rate hikes, the Fed says it “will be patient as it determines what future adjustments . . . may be appropriate.” (January 2019)
In the study, each participant then received new information in one of eight forms—such as the USA Today report on the FOMC statement—and responded to the inflation-expectation questions again. They answered the same questions three and six months later without new information.
Participants seemed to absorb the Fed’s message better from its original announcement than from the media translation. Presented with only the USA Today story, participants reduced their overly high inflation expectations by 0.5 percentage points relative to the control group. (The control group was given no new inflation information.) Participants that read only the Fed statement for the same event came to more-realistic expectations about inflation, adjusting their forecasts downward by 1.2 percent.
Coibion, Gorodnichenko, and Weber write that “relying on the media to transmit the central bank’s message is unlikely to be very successful: not only do many households not follow news about monetary policy but even when exposed to news articles focusing explicitly on monetary policy decisions, these news articles seem to be heavily discounted by the public due to their source.”
A simplified Fed announcement aimed directly at consumers also produced more-accurate inflation expectations than news articles, according to the findings. Two groups of participants were told only that “the inflation target of the Federal Reserve is 2 percent per year,” or that “the US Federal Open Market Committee (which sets short-term interest rates) forecasts [a] 1.9 percent inflation rate in 2018.” These participants adjusted inflation expectations about as much as those given the denser FOMC announcement.
The study finds strong, but not more accurate, responses to other straightforward statements. When told the unemployment rate was lower than what they believed, participants slightly lowered their inflation expectations. In fact, reductions in unemployment are typically associated with higher inflation.
Another group raised its inflation forecasts more dramatically when told gas prices had risen 11 percent in the past few months, although gas-price trends are not good indicators of overall inflation.
Before they received any new information, the lower-income and less-educated participants in the study reported inflation expectations that were more out of sync with reality than other participants. However, the researchers report a wide range of answers from all groups, including people with undergraduate degrees and higher. Race, access to credit, spending plans, and shopping habits did not appear to influence participants’ reactions to the information they received.
Rising inflation generally makes home renovations and new cars more expensive. Therefore in theory, participants who learned that the Fed’s inflation target was significantly lower than they had estimated could make more big-ticket purchases than they might have otherwise.
Did the study participants adjust their spending to match their adjusted inflation expectations? The researchers plan to find out with a study starting in January 2020, after Nielsen provides data on actual household spending. If consumption didn’t change, the Fed may need a different communication goal: convince the public that the spending, or savings, the Fed desires is really in households’ best interests.
Olivier Coibion, Yuriy Gorodnichenko, and Michael Weber, “Monetary Policy Communications and Their Effects on Household Inflation Expectations,” Working paper, January 2019.
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