Singapore Consumer’s Inflation Expectations and Creation of Singapore Index of Inflation Expectations

Central bankers are often in an unenviable position. Their monetary policy and the effectiveness of their policy are largely determined by the expectation of future inflation of consumers and the business sector. Consequently, measuring the inflation expectations is important to the Central bankers. Unfortunately, obtaining a good measure of inflation expectations in the population is challenging. Most central banks rely on Surveys of Professional Forecasters to benchmark future expectations both in terms of point and probability (density) forecasts. While the forecasts provide an excellent source of disagreement that might exist among experts, it may not reflect well on the disagreement that exists among the economic agents. Similarly, it may not give us a good estimate of the level of uncertainty that exists among the population about future inflation rates. Both the disagreement and the uncertainty are important to measure Central bankers‘ ability to anchor the inflation target through communications. The aim of this report is to highlight a broad spectrum of issues that brings about the measurement of the disagreement and the uncertainty and the formation of inflation expectations among economic agents. Through a survey of approximately 400 consumers in Singapore‘s households we find several interesting results. First, the disagreement and the uncertainty are indeed two different concepts. The uncertainty is larger than the disagreement in Singapore. Second, in the medium term of one year, household decision-making and awareness of economic conditions facing the household play a crucial role forming current expectation. The inflation expectations are also affected by the long term relationship of the individual through citizenship status or length of stay. Third, we find that for the long term or five year ahead, the level of confidence in future equity investment plays a crucial part in expectation formation. Finally, although we find that the level of uncertainty plays a significant role in periods of stress, following media coverage on economic issues plays a very significant role in longer term inflation expectation. We find the SKBI-MasterCard Singapore Index of Inflation Expectations for the current year (SInDEx1), which is a weighted average of Headline and Core Inflation rates, has remained almost the same in both the September and December waves at 4.62%. The five year ahead SKBI-MasterCard Singapore Index of Inflation Expectations (SInDEx5) has slightly gone down from 5.2% in September to 5.16% in December. 1. Importance of Inflation Expectations Inflation expectations not only play an important role in understanding and predicting consumer and firm behaviour, but also in galvanising monetary policy for Central banks. A wide range of household decisions, such as investment, spending and saving, are known to be affected by inflation expectations. When prices and wages are set, the expectations of future inflation are often taken into account. If the inflation is expected to be higher in the future, employees may demand higher nominal wages to offset the increasing cost of living and companies may be inclined to increase prices to offset the increasing cost of production. Consequently, there are significant long term impacts of inflation expectations on jobs growth and wage outlook. High inflation is bad. High inflation injects noise into the price system and makes economic and financial planning difficult. As Bernanke (2007) pointed out, “high and persistent inflation undermines public confidence in the economy and in the management of economic policy generally, with potentially adverse effects on risk-taking, investment, and other productive activities”. This is why low inflation is an objective of many Central banks’ monetary policy and the control of inflation is vital to good monetary policy. Singapore is no exception. Q1 2012 6 1. We would like to thank Gladys Ng for comments on the report and all the respondents who have participated in the pilot survey. The views expressed in this report are that of the co-authors and not of SMU or SKBI or MasterCard. The credibility of Central banks is the key factor to determine the effectiveness of an anti-inflation policy, and naturally, the Central banks need to know how credible they are. The communication between the Central banks and consumers and business sectors is important. For this reason, the Central banks have to communicate inflation target either explicitly or semiexplicitly to anchor long-run inflation expectations of the public. Good communication should help to reduce not only the disagreement about future inflation between economic agents but also the uncertainty about future inflation of each economic entity, which we view as different concepts. It is important to point out that inflation expectations are different from inflation forecasts. Central banks may use inflation expectations to improve their inflation forecasts and may also use their inflation forecasts to communicate their inflation target. However, how people form expectations is not a concern per se when Central banks obtain inflation forecasts. 2. SKBI-MasterCard Survey of Singapore Consumers’ Inflation Expectations Inflation expectations surveys are the most common instrument for gauging inflation expectations and attitudes. The number of surveys has increased around the world. For example, the widely cited “Livingston Survey” of Professional Economists (conducted by the Federal Reserve Bank of Philadelphia), Reuters/ University of Michigan Survey of Consumers (“the Michigan Survey”) and the Bank of England/GfK NOP Inflation Attitudes Survey, use questionnaires on a cross section of experts, individuals or households based on demographic, wage and price related questions. We cannot understate the importance of the accuracy of such surveys. In the US context, it has been succinctly observed that “. The Federal Reserve needs reliable measures of expected inflation to formulate and gauge the thrust of monetary policy. In fact, inflation expectations have become more important to the Fed given the diminished stability of the link between the monetary aggregates and GDP expenditures since the early 1980s, and the greater role which has been thrust upon expected real shortterm interest rates in the implementation of Federal Reserve policy. ” (Thomas Jr., 1999, p. 125) In Singapore, the Monetary Authority of Singapore (MAS) Survey of Professional Forecasters has a long history. The Survey, which has been conducted quarterly since 1999, collates and publishes forecasts produced by 20-30 professional economists and analysts covering the key macroeconomic indicators of Singapore economy, including GDP, expenditure components, sectorial variables, financial variables, unemployment rate, and inflation. Both point forecasts and density forecasts are elicited. In particular, inflation expectations are captured through the inflation forecasts at three different forecast horizons: an annual average forecast for the current calendar year, the next calendar year, and for the current year’s quarters. The instrumental question asked is about the year-to-year growth in percentage terms on Consumer Price Index (CPI). The SKBI-MasterCard Survey of Singapore consumers, which has been conducted since September 2011, collects answers to carefully targeted questions designed by us, from about 400 randomly selected consumers in Singapore. Before we fielded the full survey at this big scale, we ran two pilot surveys, one offline with 104 respondents and one online with 22 respondents. These two pilot surveys not only helped us to fine tune our questionnaire but also gave us similar results to what we eventually obtained from the formal full-scale survey. We now discuss some of the unique features of our Survey in the Singapore context. First, we use a reasonably large sample size, in the neighbourhood of 400 consumers. We understand that the number of respondents varies widely in the existing inflation expectations surveys. The oldest continuous survey for inflation and other key macroeconomic variable expectations, started as early as 1946, was a semiannual survey with as few as 10-60 professional economists. The much broader scale quarterly BOE/Gfk NOP Inflation Attitudes Survey, May 2011 used 2000 respondents and interviewed a quota sample of 2045 (Barnett et al, 2010). The New York Fed in collaboration with others started the Household Inflation Expectation Project (HIEP) in 2006 and conducted a modification of the Michigan Survey with 500 respondents each month (Bruine de Bruin et al., 2010). Philadelphia Fed Survey of Professional Forecasters used about 44 experts and the 7 MasterCard Worldwide Insights / SKBI Working Paper MAS Survey used about 20-30 experts. Some of these surveys are conducted based on the assumption of a representative cross section of the households or decision-making individuals. We recommend that 400 respondents should be sufficient for our purpose since Singapore is a city-based economy and has less regional heterogeneity than many other countries. Second, we are careful with the choice of wording of the questions. One of the major issues identified by survey designers is that “. relatively little is known about how respondents interpret the survey questions, how their interpretation affects their responses, and how much their expectations influence their behaviour and beliefs about the economy. ” (Bruine de Bruin et al., p. 1). This has implications on both the accuracy of the results vis-à-vis the assumptions of rationality of individuals (Thomas Jr., 1999). One important aspect of the question asked in the Michigan Survey is what changes respondents expect of “prices in general”. Although this is a simple question, it brings forth different interpretations, depending on the actual prices faced by individual respondents, rather than addresses the issue of overall