2024 Bank of Italy-SUERF Conference on
'Inflation, Inflation Expectations, and Policy: New Perspectives'
Welcome address by Luigi Federico Signorini
Senior Deputy Governor of the Bank of Italy
Rome, 18-19 November 2024
Ladies and gentlemen,
Naturally enough, people's perception of, and expectations about, the inflation rate
have attracted much attention in the past few years.* When the Bank of Italy last hosted
a conference on inflation expectations two years ago, inflation had surged in many
countries to levels not seen in half a century. This was in sharp contrast to a previous
era during which inflation had long remained below target, and monetary policy had
been very loose. Starting in early 2021, the picture had changed. The recovery from the
pandemic shock, supply chain disruptions, and then - most critically - Russia's attack on
Ukraine sparked sizable increases in key input prices, which quickly passed through to
consumer prices.
For central banks, whose core mandate is price stability, that was a once-in-a-generation
challenge. Spikes in global energy and commodity prices could not be neutralised by
monetary policy, of course. What we needed to do was to ensure that those price changes
did not ignite an inflationary spiral which would then be difficult and costly to stop.
Monetary policy had to change course fast. The risk of inflation expectations de-anchoring
and the risk of second-round effects had to be tackled forcefully.
In this framework, the perceptions and attitudes of price- and wage-setters were a key
link, and obtaining reliable information about them was therefore important. Over time,
this has spawned much thinking about the way people form views about inflation and
the channels through which such views affect their behaviour. There has also been a
renewed interest in data collection. Thus, one legacy of the inflationary episode of the
past few years has been a growing body of research, as well as a rich agenda for future
work.1 Today's conference fits nicely in this trend.
I shall briefly touch on three questions that are especially relevant to the concerns of
central banks and, while not new in any sense, have been the subject of much thought
and analysis in recent years.
The first issue is: how do expectations propagate, and possibly amplify, inflationary
shocks?
Expectations can make inflation more persistent or, worse still, initiate self-fulfilling
inflationary spirals. I am sure this conference will discuss the relative importance of several
such propagation channels. Let me recall a few that are at the centre of policymakers'
concerns.
The most obvious channel is the way inflation expectations influence nominal wage and
price setting. Anticipating rising general inflation, workers may pre-emptively demand
higher wage increases and firms set higher prices. The way in which such expectations
are formed (whether and to what extent expectations are backward-looking, for instance)
appears crucially relevant to the issue of inflation persistence.
A second channel concerns real interest rates. To the extent that an increase in
expected inflation is not immediately reflected in a change in nominal rates, agents
will perceive a temporary decrease of the real rate, which may affect their decisions
on the inter-temporal allocation of consumption and investment. In the short term,
this may in turn push aggregate demand and inflation in the same direction in which
expectations initially moved.2
There are further potential effects. Some argue, for instance, that a third channel, which
may reinforce the first, works through the conditions that determine firms' pricing power.
With low inflation, firms are reluctant to raise prices for fear of losing customers. However,
if consumers start to believe that inflation is rising, firms' 'fear of customer antagonism'
fades, making it easier for them to pass on a marginal cost increase to their price lists.3
If any of such self-reinforcing mechanisms is at work, understanding inflation expectations
and finding ways to influence them is important for policymakers. The question then is:
how do you get reliable information on agents' expectations?
One way is to ask agents directly. Surveys in which consumers, firms, or professional
forecasters answer questions concerning their subjective beliefs about future inflation
are widely used as a tool for research and policy-making.
This brings me to my second point:
How valuable is the information content of survey-based measures of inflation
expectations?
Despite widespread reliance on survey data in much empirical literature in the social
sciences, the (usually implicit) condition that respondents answer questions truthfully
or meaningfully cannot always be taken for granted. The literature points to several
potential sources of noise or bias. In general, survey responses may be driven by
strategic considerations, social desirability motives or other specific reasons to misreport
the facts. In the absence of monetary or other incentives, respondents may simply be
poorly informed, or inattentive ('cheap talk'). Some of these issues are likely to be less
important for inflation expectations than for other types of surveys, such as wealth and
income surveys, or political opinion polls. Others, however, are specifically relevant to
inflation expectations. Especially in the case of consumer surveys, respondents may be
unfamiliar with the concept and measure of inflation, confuse it with the level of prices, or
just have difficulty handling percentages.4 There is plenty of anecdotal evidence of that.
Furthermore, their perception may be disproportionately influenced by the prices they
observe more frequently, typically those of non-durable goods, or they may unconsciously
assign more weight to price increases than decreases.5
Caution is therefore in order: self-reported data should never be taken at face value
without the corroboration of external information. What does the evidence tell us?
It is well known that survey-based measures of inflation expectations are systematically
biased upwards relative to ex-post outcomes, though changes in actual inflation and
changes in consumers' inflation perceptions and expectations appear to be highly
correlated.6 Furthermore, survey-based inflation expectations are substantially dispersed
across agents and volatile in the time series: they differ systematically across demographic
groups - gender, age, income, and other characteristics - and reflect the specific price
changes that individuals observe in their daily lives7. Some studies have also shown that
changes in the variance and skewness of households' inflation expectations are predictive
of near-term inflation developments.8
So, despite all the noise and bias, there is signal in survey data after all.
Here comes the third question:
What do the data tell us about the proposed expectations-based channels of
inflation propagation?
I do not need to tell this audience that this is a vast field. Just to mention a few
policy-relevant topics, key questions include the time structure of the correlation
(i.e., ultimately, whether expectations are forward- or backward-looking, and, possibly,
in which direction causality runs); the cross-section dimension (i.e., the extent to which
individual responses reflect each household's characteristics and the way they process
information, as heterogeneity may influence the transmission of monetary policy);
the role played by the information available to the respondent in the formation of
expectations.
One should always bear in mind that a conceptual distinction should be made between
issues pertaining to predictive accuracy (i.e., the ability of respondents to predict
future inflation correctly) and issues pertaining to behavioural relevance (i.e., the
correspondence between what people say in surveys and what actually drives their
behaviour: their underlying, implicit structure of expectations, if you wish). While both
count, policymakers arguably have an even keener interest in the latter. Survey data
offer some useful evidence of this. Certain studies, for instance, show that consumers'
behaviour in experiments appears consistent with the expectations they report in
surveys;9 other studies, making use of external data on businesses, lend support to the
idea that expectations have a discernible impact on firms' actual economic choices.10 But
there is, I believe, still a lot of ground to be explored; I see that some of the papers that
will be presented today pursue just such a line of research.
Another set of policy-relevant questions concerns nonlinearities and state-dependence.
Agents may be rationally inattentive to inflation when it is low and stable, but switch
to a different mode when it increases and becomes more volatile. This fact, which is
intuitively plausible and has some empirical corroboration, may generate nonlinearities
in agents' behaviour, including their response to policy intervention.11 Accounting for
the endogeneity of inattention is therefore important for modelling. The issue of (in)
attention also has a bearing on the discussion about communication, with agents possibly
responding differently to central bank communication depending on the inflation state.12
Survey data, if taken with a pinch of salt and accurately checked against other evidence,
may offer insights into all these possibilities.
One could, of course, go on. Be assured that I shall make no attempt to draw an exhaustive
list. My only point was to emphasise the notion that judicious and creative use of survey
data can be very productive from the policymaker's point of view. It is for this reason that
central banks and other institutions keep collecting data on expectations, and strive to
improve their quality.
At this point, it may be appropriate for me to spend just a few words on the Bank of Italy
as a producer of data. We do, in fact, have a long tradition in the collection, processing
and dissemination of various sets of statistics, including statistics from surveys. Let me
take this opportunity to mention a few that interest us here.
On the firms' side, since 1999 we have conducted a quarterly survey of businesses' inflation
and growth expectations. This survey supplies a rich set of data at a comparatively high
frequency. In this as in other cases, having our own survey yields some useful flexibility.
The Bank, for instance, was one of the first institutions to experiment with the randomised
supply of external data to a subset of respondents, an experiment that was meant to
explore the issue of how firms react to an extended set of information.13 This approach
has subsequently gained popularity.14
As for households, our longstanding Survey on Household Income and Wealth allowed
us to collect data on household inflation expectations in several waves between the
late 80s and early 90s and, more recently, since 2016. While the survey is biennial
and thus unfit for cyclical analysis, being able to cross-compare expectations with a
comprehensive set of household characteristics has enabled us to study a number of
structural aspects of expectation formation in some detail.15
To conclude: survey data are a valuable tool, whose usefulness can be enhanced by
combining them with administrative and other external data whenever feasible.
Cooperation between central banks, statistical offices and other data-collecting
institutions is precious.
These two days promise to be rich and productive, with many stimulating presentations.
Today we shall also have the pleasure of hearing Professor Michael Weber's keynote
speech and Philip Lane delivering the Marjoline Lecture whereas, tomorrow, Professor
Pierpaolo Benigno will be giving a speech on the non-linearity of the Phillips curve - that
elusive, mutable, but ultimately ever-resurgent 66-year old concept.
Enjoy the conference!
References
Afrouzi, H., and C. Yang, (2023). "Dynamic Rational Inattention and the Phillips Curve",
CESifo Working Paper No. 8840.
Anderson, E.T., and D. Simester. (2010). "Price stickiness and customer antagonism",
The Quarterly Journal of Economics, 125(2), pp. 729-765.
Arioli, R., C. Bates, H.C. Dieden, I. Duca, R. Friz, C. Gayer, G. Kenny, A. Meyler, and
I. Pavlova, Iskra, (2017). "EU consumers' quantitative inflation perceptions and expectations:
an evaluation," Occasional Paper Series 186, European Central Bank.
Binetti, A., F. Nuzzi and S. Stancheva, (2024). "People's Understanding of Inflation," NBER
Working Papers 32497.
Bruine de Bruin, W., W. van der Klaauw and G. Topa, (2011). "Expectations of inflation:
The biasing effect of thoughts about specific prices," Journal of Economic Psychology,
vol. 32(5), pages 834-845.
Cavallo, A., F. Lippi and K. Miyahara, (2024). "Large Shocks Travel Fast", American Economic
Review: Insights, Forthcoming.
Coibion, O., Y. Gorodnichenko and T. Ropele, (2020). "Inflation Expectations and Firm
Decisions: New Causal Evidence," The Quarterly Journal of Economics, vol. 135(1),
pages 165-219.
Coibion, O., Y. Gorodnichenko, and M. Weber, (2022). "Monetary Policy Communications
and their Effects on Household Inflation Expectations," Journal of Political Economy 130(6):
1537-1584.
D'Acunto, F., E. Charalambakis, D. Georgarakos, G. Kenny, J. Meyer and M. Weber, (2024).
"Household inflation expectations: an overview of recent insights for monetary policy",
ECB Discussion paper series, n. 24.
D'Acunto, F., U. Malmendier, J. Ospina and M. Weber, (2021). "Exposure to Grocery Prices
and Inflation Expectations," Journal of Political Economy, vol. 129(5), pages 1615-1639.
D'Acunto, F., U. Malmendier, and M. Weber, (2023). " What do the data tell us about
inflation expectations?," Handbook of Economic Expectations (Chapter 5), pages
1615-1639.
D'Acunto, F. and M. Weber, (2024). "Why Survey-Based Subjective Expectations are
Meaningful and Important", Annual Review of Economics, accepted for publication.
Duca-Radu, I., G. Kenny and A. Reuter (2021). "Inflation expectations, consumption and
the lower bound: Micro evidence from a large multi-country survey", Journal of Monetary
Economics, 118, 120-134.
Haaland, I., J. König, C. Roth and J. Wohlfart, (2024). "Information Experiments",
Encyclopedia of Experimental Social Science, January 2024.
Kiley, M., (2021). "Policy Paradoxes in the New Keynesian Model," FEDS Working Paper
No. 2014-29.
Reis, R. (2021), "Losing the Inflation Anchor", Brookings Papers on Economic Activity,
pp. 307-361.
Rondinelli, C. and R. Zizza (2020), "Spend today or spend tomorrow? The role of inflation
expectations in consumer behaviour", Temi di Discussione n. 1276, Banca d'Italia.
Weber, M., B. Candia, H. Afrouzi, T. Ropele, R. Lluberas, S. Frache, B. Meyer, S. Kumar,
Y. Gorodnichenko, D. Georgarakos, O. Coibion, G. Kenny, and J. Ponce, (2024).
"Tell Me Something I Don't Already Know: Learning in Low and High-Inflation Settings",
Econometrica, Forthcoming.
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