Here’s good news for US Federal Reserve chair Jerome Powell: research by Chicago Booth’s Stefan Nagel suggests that the post-COVID spike in inflation was too fleeting to have a real impact on consumers’ outlooks. That should be a relief for the US central bank, which in 2022 embarked on a course of interest-rate cuts designed to cool inflation without crashing the economy.
But the research also finds a downside for Powell and other monetary policymakers: expressing an intent to quell inflation doesn’t do as much as raising rates.
“The public’s views about the expected long-run inflation rate are changing only slowly in response to inflation observations,” Nagel writes. “Moreover, beliefs are changing in response to actually observed inflation, not in response to central bank communication policy commitments.”
The spike in prices that began as the COVID pandemic receded served as a natural laboratory for many researchers interested in inflation. For Nagel, it was an opportunity to update earlier work, conducted with University of California at Berkeley’s Ulrike Malmendier and published in 2016, that established how people’s views of future inflation are profoundly shaped by their past experiences. (For more, read “Stefan Nagel says not to lean too much on experience.”)
The researchers analyzed 57 years of data from the University of Michigan’s Surveys of Consumers, which ask respondents for their expectations on short- and long-term inflation. Lived experience was an important factor in influencing consumers’ views, they find. At the time Malmendier and Nagel conducted the research, an entire generation had come of age with no experience of inflation. After decades of it steadily falling, young people had lower inflation expectations than did older people, who had lived through the stubborn inflation of the late 1970s and early ’80s.
But after prices surged in 2021 and 2022 at a pace that rivaled that Great Inflation period, Nagel updated the data series. His findings corroborate the weightiness of lived experience: This time, with the COVID price spike looming large, younger people quickly caught up with the older generation in terms of their predictions, eventually expecting inflation to stay higher for longer. Older people, who had lived through several cycles of rising and falling prices, reacted less to the new inflation experiences.
The latest research carries the findings a step further. Because individuals are so deeply influenced by their shared experience of inflation, monetary policymakers must be committed to managing—or what the study describes as “leaning against”—price fluctuations, Nagel argues.
Simply talking about the intention to stay the course until inflation is under control isn’t enough: It takes persistently high interest rates to bring prices down and ultralow ones to nudge them higher. As Nagel writes, “individuals who are learning from experience need to be able to see inflation close to target for a prolonged period for their beliefs to move towards the target.”
Because this requires that monetary policymakers act aggressively, it could have a notable impact not just on inflation but on real interest rates, Nagel finds—and not just on the short-term rates that the central bank is generally considered to control, but on longer ones as well.
There is reason to believe that when consumers expect prices to rise more quickly in the future, they are more likely to pull forward their spending, which may then contribute to higher inflation, according to the study. And as Nagel stresses, consumers are less impressed by “credible policy commitments” from central bankers than long periods of low rates. “The crux is credibility,” he writes. People need to see inflation tamed to believe it.
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