Governor's notes on the inflation expectations of households
Prepared for the discussion at the General Council Meeting on 26 September 2024
Aleš Michl
Good morning, President Lagarde, dear colleagues.
Let me give you an insight into how we (at the CNB) approach the inflation expectations of
households.
Methodology
We have data on the short-term (12-month) inflation expectations of households from monthly
business and consumer surveys. The surveys have been conducted for the Czech Statistical
Office and the European Commission by Data Collect, a market research company. The
survey is conducted via telephone interviews, using a sample of 1,000 randomly selected
households.
Since August 2015, we have numerical estimates of:
1. Expected inflation: respondents are asked, "How do you think consumer prices will
develop in the next 12 months compared to the previous 12 months?"
2. Perceived inflation: respondents are asked, "How much do you think consumer prices
have changed over the past 12 months? Please estimate in per cent."
Inflation expectations: households vs. financial market analysts and business
managers
Inflation expectations in the Czech Republic
(12-month horizon, %)
households business managers (quarterly survey)
financial market analysts inflation target (2%)
25
20
15
10
5
0
2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Source: Czech National Bank, Data Collect
Across the entire sample, households consistently expected higher inflation than business
managers and financial market analysts. This can be observed in most countries.
Households' inflation expectations were above the inflation target of 2% even before inflation
began to rise.
On the other hand, analysts and business managers had stable expectations before the
pandemic, anchored at 2%.
Actual, perceived and expected inflation
CPI inflation inflation expected by households (12 months ahead)
inflation perceived by households inflation target (2%)
40
35
30
25
20
15
10
5
0
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Source: Data Collect, Czech Statistical Office
Both expected and perceived inflation were higher than actual inflation; perceived inflation was
more than twice as high as published inflation at the peak of the inflation wave in 2022.
Monetary policy response in the 2nd half of 2022, when I became governor
CPI inflation
inflation perceived by households
inflation expected by households (12 months ahead)
CNB repo rate (%)
inflation target (2%)
35
30
25
20
15
10
5
0
2016 2017 2018 2019 2020 2021 2022
Source: Data Collect, Czech Statistical Office
I became governor in July 2022. At that time, actual inflation was 17.5%, the key interest rate
was 7%, perceived inflation was 35% and inflation expected in 12 months was 27%.
The textbook approach prescribes that the central bank should keep raising key interest rates.
When inflation expectations rise, interest rates should rise to control demand and inflation.
Our approach: We kept interest rates stable; the repo rate remained at 7%. This approach
was controversial and contrary to the mainstream opinion of economists in the Czech
Republic.
This strategy was based on two main arguments:
(1) We concluded that inflation expectations are adaptive, and therefore ex ante real rates
would rise once inflation falls. We expected inflation would peak soon, as supply shocks were
not repeated and inflation momentum was declining.
(2) We observed a sharp decline in household consumption, a contraction in lending and a
slowdown in money supply growth (M2).
Expected and perceived inflation are highly correlated
Expected inflation is closely related to perceived inflation, with correlation coefficients ranging
from 0.4 to 0.74 in different years.
This suggests that inflation expectations were/are adaptive. In addition, they are not a reliable
predictor of future inflation.
Consumption was falling despite elevated inflation expectations
We carefully analysed consumption trends, which typically reflect demand pressures in the
economy. Despite high inflation expectations, consumption fell sharply.
Household consumption across EU countries
(index, 2019 = 100)
Czech Republic
120
110
100
90
80
2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Source: Eurostat
This contradicts economic theory: higher inflation expectations ⇒ people consume more now
because they expect prices to rise in the future
Household consumption fell sharply for the following reasons:
§ A sharp decline in real disposable income
§ High savings rates, influenced by economic uncertainty (precautionary savings) and
restrictive monetary policy
Our approach to monetary policy in times of elevated inflation expectations
To summarise our strategy for taming inflation:
We decided to keep nominal interest rates stable at 7% from July 2022 to December 2023.
We focused on maintaining a strong exchange rate (through verbal intervention), which
reached an all-time high against the euro in spring 2023, making imports cheaper. In addition,
the strong exchange rate tightened monetary conditions for domestic exporters who had taken
on loans in euros.
Inflation peaked in October 2022. Inflation expectations also started to fall (due to their
adaptive nature) and ex ante real interest rates started to rise, although nominal rates were
stable.
Together, positive real interest rates and the exchange rate resulted in the tightest monetary
conditions. Lending activity fell sharply and money supply (M2) eased. The monetary
overhang disappeared over time.
We also focused on communication:
§ We emphasised that inflation momentum was declining, although annual inflation was
still high1
§ We stressed that monetary policy was working and that interest rates would remain
high for longer
Our approach to elevated inflation expectations during price stability
After two years, CPI inflation was exactly 2% in February, March and June of this year. It
currently stands at 2.2%. At the same time, the inflation expectations of households appear to
be elevated (median at 5%, mean at 11%).
CPI inflation
inflation perceived by households
inflation expected by households (12 months ahead)
CNB repo rate (%)
inflation target (2%)
40
35
30
25
20
15
10
5
0
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Source: Data Collect, Czech Statistical Office
This time, we cannot rely on the two factors dragging down consumption. Real incomes of
households are recovering, and economic uncertainty, although still high, has decreased
significantly.
Our approach: We have cautiously eased monetary policy from 7% to 4.25% since December.
We have been closely monitoring whether these expectations are having an impact on lending
activity, consumption and wage negotiations.
So far, the data shows no significant impact on consumption, which is slowly recovering. Wage
growth remained elevated at 6.5% in the second quarter of 2024, but appears to be slowing.
Lending activity is recovering moderately.
We are taking a careful approach and communicating that markets should expect higher rates
in the longer term than in the 10 years prior to Covid.