(2011a) carried out two studies to see whether individuals who think about specific price changes in forming their inflation expectations report more extreme and dispersed expectations because they focus on more extreme specific price changes. In the first study, the researchers show that those who are asked to report any or the largest individual price change tend to recall more extreme ones than those who are asked to report the average price change, and subsequently report more extreme inflation expectations. In the second study, the researchers show that among those who are asked about inflation expectations without first being asked about individual price changes, about half nonetheless think about individual items. Those who do so then report more extreme and dispersed inflation expectations. 22  In our open-ended cognitive interviews and experimental surveys, we found that respondents generally are familiar with the term “inflation” and have a good understanding of the concept of inflation (Bruine de Bruin et al. 2011a, 2012). Other studies have found that members of the general public are familiar with the term “inflation” and have a basic understanding of what it means (Leiser and Drori 2005; Svenson and Nilsson 1986; Williamson and Wearing 1996). 23  An advantage of eliciting density forecasts in this way – as opposed, for example, to eliciting values of the cumulative distribution function – is that answers are less likely to violate the laws of probability, such as monotonicity of the distribution function.

When choosing between the two investments, the respondent seeking to maximize her payoff should switch investments at most once, and if so, should switch from the one yielding a nominal return to the inflation-protected investment sooner, the higher her inflation expectations.31 We found that the choices in the financially incentivized experiment were indeed meaningfully related to respondents’ inflation expectations, on average. Differences in reported uncertainty were also associated with different choices in the experiment, in the direction predicted by theory. Deviations from expected utility maximization were more likely  29  The observed heterogeneity of expectations is important for policy purposes, since we find that agents with different characteristics act on their inflation beliefs and update their expectations in distinct ways. 30  Armantier et al. (2015). 31  This is an agent’s optimal choice under expected payoff maximization. We also show that the respondent should switch sooner to the inflation-protected investment, the higher her risk aversion and the more uncertainty she expresses in her inflation expectations. BIS central bankers’ speeches  9  to occur for respondents with low education, as well as those with low numerical and financial literacy. We were able to repeat the experiment with the same respondents six months later. We found that individual changes in expectations were significantly associated with changes in how early respondents switched between investments, and that not only the direction but also the magnitude of these changes was consistent with a simple expected utility maximization framework.