Category: expectations

Expectations and Anticipations

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June 16, 2024

This week’s letter continues my study of expectations, focusing on the political aspect. While some economists have treated expectation and anticipation as synonyms (the Stockholm school, for one), I want to distinguish between the two. Expectation is planning for or projecting into the future from an observation point in the present. Anticipation is visionary, an imaginative leap into the future in which some event or state has already happened. Anticipation is intuitive; expectation is calculating.

Anticipation invokes our identity and biases as well as our imagination. Political campaigns often target our sense of anticipation with negative advertising that impugns the candidate, then implies that a vote for such a character is an association with that candidate. Imagine how bad things would be if such a person were elected. Do we really want to be associated with someone like that? At a 2008 Presidential debate between Republican candidate John McCain and Democratic candidate Barack Obama, McCain defended Obama’s character against the innuendo spread by right wing TV and talk radio personalities. Much as we deplore negative political advertising, it is effective.

In the game of chess, each player strategizes to take the other’s king. Getting to the other side of the board first does not win the game. One achieves victory by the opponent’s loss. Elections like those in the U.S. are similar to baseball or football. Preventing the opposing team from scoring will not win the game. The victorious team must also make a score. The winner must get more points than the loser, a typical characteristic of a race, which is why our type of elections are called first past the post voting. What makes an election different than a 100-yard dash are the battle tactics employed to weaken an opponent’s efforts to score votes. Successful campaigns strive to get there first while persuading voters to vote NO on their opponent. Campaigns target two separate processes we use to make choices.

One axiom of rational choice theory in economics is a completeness of preferences – that people are able to weigh the costs and benefits of two options and choose the option that maximizes their self interest. We choose an option that provides what we think will give us the most utility. Yes, we make mistakes, but the errors are random. Behavioral economists have challenged the assumption that our choices are rational, pointing out biases that introduce systemic, not random, error in our choices. Losses have a greater impact on our senses than equal gains. Options may be too complex to evaluate fully before making a choice, so we rely on instinct.

 In Chapter 8 of his book, Optimally Irrational, Lionel Page (2023) discusses the debate and presents several examples that test the axiom. Given two grocery lists, could you pick the best option? Consider there might be twenty or more items on the list and a grocery store carries thousands of items. How could any person decide the best option? This past week, after checking out my groceries, I picked up what I thought was the receipt that had fallen out of my pocket. With a glance, I knew it was not mine because there were a few items on the list that I would never buy. I realized then that I could choose between two random grocery lists in less than a minute. I would scan the list for things that I definitely did not like or want. The list that had the fewest of those would be my choice.

When we do have difficulty making choices, it is because we are trying to choose the best, not the worst, option. Page cited (p. 101) an episode of the Big Bang Theory where Sheldon had difficulty choosing between two computer game consoles. He had approached the problem in a very analytical manner typical of Sheldon and was unable to choose. The shortcut, or heuristic, of decision-making that we use in our daily lives is not finding the best, but establishing the worst of two options. We know our dislikes more than our likes because our dislikes amplify the cost of our decisions, helping us choose the cheaper option with less deliberation. Secondly, identifying the worst alternative makes it more probable that we can live with our decision.

A successful political campaign structures its rhetoric to take advantage of this shortcut in decision making. Just before the 1980 election, candidate Ronald Reagan posed a question to President Carter at an October debate: Are you better off than you were four years ago? Despite the word “better” in the question, this was an “identify and reject the worst” choice using both rational expectations and more imaginative anticipations. On the one hand were the empirical realities of high inflation and unemployment, and the energy shortages that voters had experienced during Carter’s term. Voters could form expectations based on that data. Reagan’s term as Governor of California during the 1960s gave voters some basis to form a rational expectation of a Reagan term. However, much was left to voters’ imaginations to construct a post-hoc, or after the fact vision of a Reagan term. This was the anticipation instinct at work. The question helped turn a  close race into a landslide victory for Reagan.

Some voters may not have a clearly defined worst or judge two candidates to be equally worse. Each may have one or two repulsive personal characteristics, political alliances or policy stances. To appeal to those voters, a political campaign offers hope that their candidate will maximize a voter’s income, personal freedom, autonomy or other circumstance like the health of the community a voter lives in. The negative approach targets the cost calculation that voters make. The positive approach appeals to the benefit calculation, but the negative approach is the more powerful. The disadvantage of the negative approach is that it can persuade voters to abstain from voting. In a national campaign for President, a voter’s abstention is neutral, but a lack of turnout can be a decisive factor in local races where a small number of voters can be the tipping point of a political victory.

I hope I have made a clear distinction between expectations and anticipations. When a person stands in the present and plans ahead for some state or event, she is expecting. When a person stands in an imagined future and looks back at an event, she is anticipating. I will take a closer look at the unintentional political alliances between voters as a result of the symbiosis between expectations and anticipations.

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Photo by Ahmed Almakhzanji on Unsplash

Keywords: campaign, election, choice, anticipation, expectation

Page, L. (2023). Optimally irrational: The good reasons we behave the way we do. Cambridge University Press.

Invisible Expectations

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June 2, 2024

by Stephen Stofka

This week’s letter continues a topic from last week, our expectations of inflation. The high inflation of the 1970s prompted a lot of debate on this topic, and I will try to cover a portion of those ideas. Hypotheses regarding the formation of expectations influence monetary policy and the manner in which the Fed raises interest rates. Different policy approaches reach across the country into the pocketbooks of many Americans. They can mean the loss of many jobs or few jobs, or the viability of buying a home.

The University of Michigan conducts a monthly survey of consumer sentiment in a rotating sample among 500 participants. Respondents are asked to estimate the rate of inflation for the next twelve months (see here, p. 5). Inflation is a rise in the average price of all goods but in casual conversation, we often use the term loosely to refer to a rise in prices of the goods and services that have the most impact on our lives. Each of our estimates are biased but an average of many estimates should approximate a comprehensive survey of the prices of many goods. This BBC five-minute video explains this phenomenon known as The Wisdom of the Crowd when many people try to estimate the number of jelly beans in a mason jar.

The blue line in the graph below is the headline CPI that tracks a basket of goods and excludes expenses like the employer portion of health care insurance. The Fed pays more attention to the PCEPI, the green line in the graph below. That methodology is based on actual expenditures in various sectors of the economy, including employer paid health insurance. Notice how closely the average estimates of inflation approximate this broad measure of price movement. In the April 2024 survey, expectations averaged 3.2%, a big decrease from over 5% in 2022 but a slight rise from 2.9% in March.

How do we form inflation expectations? There are two hypotheses, and they are distinguished by how errors occur in our expectations. Adaptive expectations was a predominant hypothesis until the 1970s. It holds that we revise our forecasts up when actual inflation is higher than we expected, and down when inflation data indicates that our forecast was too high (Blanchard, 2017). Imagine that we are offered a discount at the doctor’s office if we guess our weight within three pounds. We base our guess on a previous weight reading. If it is too low, we lose our discount so the next time we revise our guess higher. Under this hypothesis, our expectations are very much guided by past experience and our forecast errors are systemic. To tame high inflation, monetary policy must act like a shock that induces a recession and alters the expectations of investors and consumers.

In August 1979, during the Carter administration, Paul Volker assumed the position of Fed chair. In October, the Fed raised interest rates 1.5%, then lowered by a half-percent in November, then raised them again by a half-percent in December. In those three months, sales of new one-family homes (HSN1F) dropped 25%. A few months later, in the spring of 1980, came another interest rate shock of a 3.5% increase over two months and new one-family homes sank by 38%. They did not begin to recover until the spring of 1982. This cattle prod approach to taming expectations was influenced by the adaptive expectations hypothesis.

Statistical tests done in the early to mid-1970s showed that we paid much more attention to ongoing conditions than previously thought. This contradicted the notion that our expectations relied mostly on past experience. Two economists, Robert Lucas and Thomas Sargent presented a rational expectations hypothesis claiming that we form the best inflation forecast we can with the information available to us. Rational does not mean perfect. Errors in our forecasts are random and arise from unseen shocks (Humphrey, 1985). The critique against this hypothesis was that people were too naïve or uninformed to form rational expectations. Information frictions blurred the distinction between rational and non-rational (Angeletos et al, 2021).

 Over the past several decades, the rational expectations hypothesis has guided policymaking at the Fed. If the Fed presents a convincing policy commitment to steer inflation toward a particular target, investors will change their behavior in accordance with their belief in the Fed’s commitment. Economist Roger Farmer (2010) has called them self-fulfilling beliefs and devotes a section of his book to rational expectations. Under this regime, the Fed uses steady, incremental rate increases and consistent policy statements to “corral” expectations like a trained sheepdog persistently badgering a flock of sheep to guide them into a holding area. By guiding expectations, monetary policy can tame high inflation without necessarily producing a recession. This has been dubbed a soft landing.

In the spring of 2022, the Fed under Chairman Jerome Powell raised rates a half percent a month, a steady rate to let everyone know that the Fed was serious. From the spring of 2022, the number of new one-family homes did not fall. That was the rational expectations hypothesis at work. The Federal Reserve as sheepdog. As with any comparison, there are a number of other factors. My point here is that ideas about people’s motivations and behavior make a concrete difference in the lives of ordinary people.

We respond to high inflation with behavior that can exacerbate inflation. Next week I will look at several scenarios that illustrate why the Fed is concerned about managing consumer and investor expectations.

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Photo by Hassaan Here on Unsplash

Keywords: housing, interest rates, monetary policy, adaptive expectations, rational expectations, inflation

Angeletos, G.-M., Huo, Z., & Sastry, K. A. (2021). Imperfect macroeconomic expectations: Evidence and theory. NBER Macroeconomics Annual, 35, 1–86. https://doi.org/10.1086/712313

Blanchard, O. (2017). Macroeconomics (Seventh ed.). Boston, MA: Pearson Education. p. 337. This is an intermediate economics textbook.

Farmer, R. E. A. (2010). How the economy works: Confidence, crashes and self-fulfilling prophecies. Oxford University Press. This book contains succinct descriptions of various economic theories that have influenced policy and is aimed toward the general reader.

Humphrey, Thomas M., The Early History of the Phillips Curve (1985). Economic Review, vol. 71, no. 5, September/October 1985, pp. 17-24, Available at SSRN: https://ssrn.com/abstract=2118883

Cause and Effect

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May 26, 2024

by Stephen Stofka

This week’s letter is about the causes of inflation. Inflation can be easily described as a mismatch between supply and demand but that is a tautology that does not explain how the mismatch occurred. For hundreds of years, scholars and academics have identified various components of inflation’s causal web but identifying a primary cause has inspired enthusiastic debate. In the past century, economists have built sophisticated mathematical models which failed to predict a subsequent episode of inflation or predicted an inflation that did not occur. Economic models predicted that large government support during the financial crisis fifteen years ago would lead to higher inflation. It did not. Some economists were surprised at the extent and strength of the inflationary surge following the pandemic. In hindsight, turning off the world’s economic supply engine for even a short time was likely to have a strong effect on prices.

In The Power of Gold, Peter Bernstein (2000) recounts the causes that sixteenth century scholars gave for the persistent inflation in Europe during the 1500s. Those factors included “the decline of agriculture, ruinous taxation, depopulation, market manipulation, high labor costs, vagrancy, luxury and the machination of businessmen” (p. 191). Five hundred years later, most factors are relevant today in an altered form. With more sophisticated analytical tools, economists have developed a better understanding of these causal influences but that understanding has not led to better inflation forecasting. These factors can be grouped into those that affect supply or demand. Missing from that list was war, a common cause of inflation that distorts both supply and demand.

Prior to the severe cooling of the Little Ice Age in the 1600s, England and northwest Europe experienced a cooler climate that affected harvests. In an economy that relied mostly on agriculture, a poor harvest, or decline in agriculture was a supply constraint that pushed up prices. The demand / supply relationship is a fraction that helps explain a change in price. A lower supply, the denominator in that fraction, equals a higher price. Repeated waves of the plague and other general pandemics led to a depopulation that reduced the work force and pushed up the subsistence wages paid to workers. Employment in the U.K. has still not recovered from pre-pandemic levels, contributing to slightly higher inflation in the U.K. compared to the U.S.

High labor costs are the essence of a cost-push theory of inflation. When there is not enough supply of labor, workers are able to command higher wages. In many businesses, labor is an employer’s highest cost. Because employers markup all production costs, that markup increases the rise in prices. If employees get an extra $1 wage and the employer marks it up 50% to cover operating expenses, required taxes, fixed investment and profit, then the price will rise $1.50. The additional wage income will increase demand, resulting in a wage-price spiral that further exacerbates inflation. Any policy that reduces the supply of labor can be included in a cost-push theory of inflation.

Vagrancy, or homelessness, was a new phenomenon in the 16th century as Europe emerged from the feudal system in which workers were bound to the properties they cultivated. Policies that tolerated idleness of any sort reduced the work force and gave workers more bargaining power. Scholars of that century would be puzzled by modern day unemployment insurance which “rewards” workers for idleness. The mathematics of probability and risk that makes any insurance program feasible was barely in its infancy. By the late 17th century, Blaise Pascal and Pierre de Fermat had developed probability analysis, giving pools of underwriters gathered in coffee houses near London’s Royal Exchange the mathematical tools to sell insurance policies on many risky events (Bernstein, 1996, 63, 90).

Ruinous taxation consisted of import taxes and the debasement of hard metal currencies by the sovereign as a substitute for taxation. Import taxes on necessary commodities increased production costs, creating a cost-push effect. To repay debts incurred during war campaigns, rulers debased the currency by mixing base metals with gold or silver. In the 4th century B.C., Dionysius of Syracuse in Sicily had all the coins in his kingdom restamped to double their value so he could pay his debts (Bernstein, 2000, 48). Monetarists claim that an excess supply of money is the root cause of inflation. The economist Milton Friedman, never one to equivocate, stated flatly that inflation was “always and everywhere a monetary phenomenon.” In the Wealth of Nations, Smith (1776; 2009) noted that gold discoveries in the Americas had driven prices higher in England. A higher supply of money of any form will increase demand so this root cause is a subset of demand-pull theories of inflation.

Popular and scholarly opinion often points an accusing finger at the business class, whose conspiratorial machinations are thought to be responsible for rising prices. Historian Barbara Tuchman (1978, 163-165) described the power that merchants had acquired as the Third Estate under feudalism in 14th century France. Because many merchants were free citizens of a town and not subject to the rule of a noble, they enjoyed wealth and privileges like that of nobles, and at the expense of the workers who regarded them with scorn and envy. In Part 1, Chapter 10 of the Wealth of Nations, Smith wrote “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” Responding to the global inflation following the Covid-19 pandemic, some op-ed writers and Twitter threads were convinced that collusion by business interests was the primary cause of the inflation.

The reasoning and analysis by thinkers of centuries past did not include the role of expectations in fostering and feeding inflation. Expectations are a key part of some prominent models because supply and demand operate on different time scales. The companies that make up the supply chain must anticipate the level of demand for a product or service before the demand manifests. Each year, the risk of being wrong increases in an economy marked by technological change and rapidly evolving tastes. Inflationary expectations needs a bit more space and will have to wait until next week. Have a good holiday weekend!

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Photo by Elias Kauerhof on Unsplash

Keywords: expectations, money, taxation, unemployment, supply, demand, cost-push, demand-pull

Bernstein, P. L. (1998). Against the Gods, the Remarkable Story of Risk. John Wiley & Sons.

Smith, A. (2009). Wealth of Nations. Classic House Books.

Tuchman, B. W. (1978). A Distant Mirror: The calamitous 14th Century. Alfred A. Knopf.

Crystal Ball

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February 25, 2024

by Stephen Stofka

This week’s letter is about the public’s expectations of inflation. The interest rate setting committee of the Fed indirectly controls the borrowing costs on our mortgages, credit cards and auto loans. The committee pays attention to public expectations of inflation because we respond now to what we see as potential threats. A fear of “making a mistake” in a job interview can make us nervous, increasing the chances that our behavior will decrease our chance of securing that position. A consumer who expects higher gas prices next year may buy a more fuel efficient vehicle this year.

Consumers must anticipate their future circumstances and income when they decide between different consumption bundles. Should they spend more on housing and live closer to work or get more house for their dollar and have a longer commute? Invest time and money in college, including the loss of income while attending school. Consumers must decide how much to spend and how much to save. Despite the difficulty of such decisions, many consumption choices are made on a shorter time scale than the suppliers who provide those goods and services. To survive, a business must live in the future, anticipating the trends of customer behavior that shape demand for its products or services. Since the pandemic, the shift to work at home has hurt many downtown businesses that depend on foot-traffic. There aren’t enough office workers to support some types of businesses.

In his General Theory published in 1936, John Maynard Keynes gave a prominent role to investor expectations. John Muth (1961) presented a more formal model that he termed “rational expectations.” In the 1970s, Thomas Sargent and Robert Lucas developed more extensive models to understand how people responded to the stagflation of the 1970s. The formation of expectations is an important economic variable and remains a hotly debated topic among economists.

Each month the New York branch of the Federal Reserve surveys a rotating sample of 1300 people to gauge their expectations of overall price changes as well as principle expenses like housing, food and gas (questionnaire pdf here). The Fed provides data on the past decade of surveys which allows us to assess changes in public expectations. As I explored this data with graphs, I was surprised at how closely expectations conformed to a textbook model that students are taught in an intermediate macroeconomics class. Macro is hard because there are few natural experiments to test theories and models. The pandemic led to a series of events that provided such a natural experiment.

I’ll begin by comparing actual inflation to public expectations of inflation a year earlier. The first graph is actual inflation and the predictions of that inflation from a year earlier. From 2014 to 2020, the median value of expected inflation, the blue line, stayed anchored in the 2.5% to 3% range even when actual inflation, the orange dotted line, was below that. Lower inflation was not a threat to people’s pocketbooks so there was little reason to revise their estimates downward. We have a well-studied risk aversion, meaning that we place greater weight on loss than we do on gains. In this case, lower than expected inflation is a gain. Economists and the general public were both caught off guard when inflation surged higher in 2021.

As soon as inflation rose above long-term averages, as it did in 2021, survey respondents revised their estimates of next year’s inflation. Higher inflation is a threat to our finances, so we pay greater attention. However, survey respondents based their estimates of next year’s inflation on this year’s actual inflation. Is that a good estimating procedure? Maybe not, but estimating trends requires knowledge, practice and error checking to improve our skills. Many times we use shortcuts, called heuristics, instead. I will leave a textbook explanation of the formation of inflation expectations in the notes.

How do we survive using shortcuts? One of those shortcuts is our degree of uncertainty. There are fewer traffic accidents at roundabout intersections because they introduce a degree of uncertainty that causes us to be more cautious. The median percent of uncertainty jumped in March 2020 when pandemic restrictions were announced. When Biden took office a year later uncertainty remained at this elevated base. As the economy reopened in the spring of 2021, supply disruptions became apparent. “When are you going to get more of these in stock” was met with “We don’t know. They’re on a boat somewhere in the Pacific.” While people sat at home during the pandemic, they bought a lot of goods from online retailers like Amazon. The reopening of service-oriented businesses caused another price shock as the economy transitioned from goods-heavy back to one that relied heavily on services.

The peak of uncertainty occurred in mid-2022, shortly after the Fed began a series of consecutive interest rates increases that would lift the benchmark lending rate by 5%. The uncertainty of survey respondents decreased in reaction to the Fed’s intention to keep increasing rates until rising inflation was tamed. I’ll zoom in on the past three years of uncertainty and the Fed’s “get serious” campaign of interest rate increases.

Despite criticism of the Fed, its intentions were credible to the public. Expectations are as difficult to measure as animal pheromones but they are real. They cause responses. Surveys are an imperfect gauge of expectations but they will have to do until someone invents an expectarometer that detects the mental disturbances in the sub-ether caused by expectations. That’s a world similar to Philip K. Dick’s Minority Report and I’m not sure we want that.

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Photo by Jan Huber on Unsplash

Keywords: federal funds rate, inflation, expectations

Note on inflation expectations: A textbook explanation is

πet = (1- θ)π̅  + θπt-1, or in words
πet   is current expectations of future inflation,
π̅   is average inflation,
θ is the weight people give to recent inflation πt-1 (Blanchard, 2017, p. 162).
From 2014-2020, survey respondents gave little weight to recent inflation, such that θ was close to 0 and expectations of inflation were close to a long-term average. As soon as inflation rose above the long-term average, θ went quickly to 1, resulting in an equation that looked like πet = (1-1)π̅ + 1π̅t-1   which simplifies to the most recent reading of inflation.

Blanchard, O. (2017). Macroeconomics (Seventh ed.). Boston, MA: Pearson Education.

Muth, J. F. (1961). Rational Expectations and the Theory of Price Movements. Econometrica, 29(3), 315-33512

The Formation of Expectations

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May 7, 2023

by Stephen Stofka

This week’s letter is about expectations – how we form them and why they are essential to our survival. This is a broad topic that encompasses several disciplines, from psychology to neuroscience and economics. Each field of study informs those in associated fields so the debate in economics is enriched by discoveries and theories in these other fields. I can only touch on a few aspects as I introduce yet another complication that might resolve some of the contradictions between theory and data.

We gain the ability to form expectations at an early age. Infants less than one year old learn what is called object persistence. If a toy falls out of their crib, they look over the edge to the floor below to see where the toy went. But object persistence is a primitive form of expectation. True expectation is a weighting of possibilities based on some criteria.

Instinctual responses often involve a primary measure of threat or satisfaction. We see this if we walk by a squirrel near a tree. If we are across the street, the squirrel may pause, poised to flee. If we draw nearer, the squirrel runs to the safety of the trunk as we approach. How far up the tree the squirrel goes depends on the distance we are from the squirrel. It would like to keep us in sight but if we get uncomfortably close, the squirrel must choose. It can hide on the side of the trunk opposite to our approach but it loses sight of us. It can go further up the tree, keeping us in sight and staying out of reach. That is a short term expectation formed in response to an immediate threat or stimulus. It is an instinctual rather than a rational expectation, the kind that economists consider.

Rational expectations are formed about the environments that produce events, or data samples, more so than the events themselves. For more than sixty years economists have been debating whether consumers have enough data and patience to construct a rational expectation. Richard Curtin (2022) reviewed the history of this debate as he argued for a theory that embraces both reason and passion as inseparable components of human decision making. In 1959, Herbert Simon protested that inadequate data does not invalidate the idea that consumers are trying to make decisions that improve their satisfaction – that’s the rational part – within the bounds of the data available to them. Simon called this bounded rationality. A few decades later Daniel Kahneman and Amos Tversky explored the biases in our decision making and their work became the foundation of behavioral economics.

Survey data reveals that consumers’ expectations of inflation overestimate actual inflation, according to Henry et al. (2023), economists at the Richmond branch of the Federal Reserve. The basis for that assertion is the University of Michigan (2023) survey of inflation expectations. The inaccuracy is fairly consistent and persistent, meaning that consumers are slow to correct their expectations as new data is released. Richard Curtin (2022) notes that as many as 40% of consumers are not aware of recent government data releases on the inflation rate, the unemployment rate and the growth rate of GDP.

Consumers cannot survive if they consistently and persistently form inaccurate expectations. There is an alternative explanation: economists and consumers are measuring two different things. Economists form their inflation expectations by measuring changes in the prices of goods and services. Consumers form their expectations in part by estimating their loss of purchasing power, their ability to satisfy their wants and needs. If consumers feel that their income gains are not keeping up with the change in prices, they may raise their estimate of future inflation.   

The prices of frequently purchased items like food and energy guide our expectations of changes to our purchasing power. Our purchases of food and energy don’t respond quickly to changes in our income. In economist speak, these items are price inelastic. We still need to drive to work and eat. Secondly, we buy food and gas frequently so our expectations of future prices depends on an averaging of the most recent prices and the last purchase we made. It is unlikely that we will form an expectation of next year’s gas prices based on a ten year average of gas prices. Thirdly, energy prices are quite volatile. I might buy gas as frequently as I go to the movies if I like movies but the price of a movie ticket does not vary as much as the price of gas. To summarize, our expectations of inflation are guided by frequency, recency and volatility.

Energy prices are particularly volatile. In this 2004 article the Federal Reserve graphed the annual changes in energy prices (red) and the broad CPI price index (blue). The difference is startling.

The wild swings in energy prices are noise. Because of that volatility, the Bureau of Labor Statistics excludes food and energy items when it computes an index of core inflation.  Core inflation is the inflation signal that economists use to predict next year’s prices.  

Consumer expectations of inflation include estimates of changes to their personal utility. As Richard Curtin (2022) has noted, it is not practical or possible to measure inflation at such a personalized level so economists average consumer expectations across the entire country. They collect price data at a broad metro area, or MSA. These urban areas can vary a lot from national inflation averages. In the chart below is a comparison of inflation in the Denver metro area and the nation as a whole. Rarely do the two series move together. When economists compile such a variety of consumer expectations into one national average, that average is less likely to accurately reflect individual or sub-regional expectations.

So economists are measuring changes in prices and consumers are estimating the change in their purchasing power. In his General Theory Keynes referred to the marginal efficiency of capital and the animal spirits of investor expectations of that efficiency that could be measured by the direction of market prices. Using that as a template, consumers’ purchasing power would be the marginal efficiency of income. We can gauge the animal spirits of consumers by the direction of total consumer purchases, which are continuing to outpace inflation. That is the best indicator of purchasing power expectations.   

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Photo by Rodion Kutsaiev on Unsplash

Curtin, R. T. (2022, September 5). A new theory of expectations – Journal of Business Cycle Research. SpringerLink. Retrieved May 5, 2023, from https://link.springer.com/article/10.1007/s41549-022-00074-w

Henry, E., Mulloy, C., & Sarte, P.-D. G. (2023, January). What survey measures of inflation Expectations Tell us. Federal Reserve Bank of Richmond. Retrieved May 5, 2023, from https://www.richmondfed.org/publications/research/economic_brief/2023/eb_23-03#:~:text=Conclusion,inflation%20every%20month%20since%202012  

University of Michigan, University of Michigan: Inflation Expectation [MICH], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/MICH, May 4, 2023.