Carola Binder on the Importance of Inflation Expectations and How Policymakers Should Respond

Episode Summary

Executive Summary: The episode examines why inflation is so salient to households, how to measure inflation expectations and uncertainty, and what those measures can—and cannot—tell policymakers. Binder argues that consumer expectations are noisy, politicized, and often more tightly linked to gasoline prices than to underlying inflation trends, so the Fed should use them cautiously alongside market-based and survey-based indicators.

Main Topics: Why households hate inflation (Priority: 5/5): Binder explains that inflation feels pervasive, erodes real income, distorts relative price signals, and increases uncertainty about budgeting and future purchasing power. Inflation as a proxy for broader economic distress (Priority: 5/5): The discussion explores how people often conflate inflation with recession, war, and general economic mismanagement, especially when high inflation coexists with weak growth. Measuring inflation expectations and uncertainty (Priority: 5/5): They compare the Michigan survey, New York Fed survey, and Binder’s own rounding-based uncertainty index, highlighting how uncertainty has risen, especially at longer horizons. How expectations affect spending (Priority: 4/5): They review the mixed empirical literature on whether higher inflation expectations cause households to spend sooner, including evidence from modern surveys and historical data. Market-based and hybrid inflation measures (Priority: 4/5): The conversation covers TIPS breakevens, professional forecaster surveys, and combined measures from regional Feds as alternative tools for gauging inflation expectations. Policy implications for the Fed (Priority: 5/5): Binder argues that the Fed should not overreact to consumer survey swings because they are noisy, politically influenced, and often driven by gas prices rather than core inflation dynamics.

Key Arguments: Inflation is widely hated because it affects almost everyone directly, makes budgeting harder, and pollutes the price signal that helps consumers make substitution decisions. Households often use inflation as a shorthand for broader disorder in the economy, which helps explain why inflation can rank above other major issues in public opinion. Consumer inflation expectations are important to monitor, but they are noisy and cross-sectionally dispersed, so the median response alone may not be a reliable policy guide. Inflation uncertainty matters as much as the inflation rate itself; Binder’s research suggests long-run uncertainty fell during Volcker disinflation and is now rising again, though not to 1980s levels. Higher inflation expectations do not consistently lead to large spending shifts; the empirical literature is mixed, suggesting expectations are a weak and difficult policy lever. The Fed should focus more on actual inflation components and market-based measures than on reacting mechanically to consumer survey readings, especially when gas prices are driving survey movements. Consumer inflation expectations are politicized, with survey responses influenced by partisan views of the incumbent administration, reducing their usefulness as a pure macro signal.

Data Points: U.S. headline CPI inflation: 9.1% - Latest U.S. inflation reading referenced at the start of the discussion Europe headline CPI equivalent: 8.6% - Comparable inflation measure cited for Europe Advanced economies with inflation above 5%: 85% - BIS annual report statistic on the share of advanced economies above the 5% threshold Emerging market economies with inflation above 5%: 64% - BIS annual report statistic on the share of emerging markets above 5% inflation Advanced-economy consumer basket above 5% inflation: ~50% - BIS diffusion measure for advanced economies Emerging-market consumer basket above 5% inflation: ~70% - BIS diffusion measure for emerging markets Gallup share naming inflation as most important problem: 18% - Latest May Gallup poll cited in the episode Historical Gallup average naming inflation as top problem: 1% - Average mentions from 1990 to 2021 cited in the Gallup article Michigan survey start date: 1978 - Consumers have given monthly numerical inflation forecasts since then New York Fed Survey of Consumer Expectations start date: 2013 - Probabilistic consumer inflation expectations survey began then Haverford teaching load: 3-2 - Binder describes teaching three classes one semester and two the next Korean War survey timing: January-February 1951 - Survey of Consumer Finances data used in Binder’s historical study Fed-Treasury Accord: March 1951 - Marks the point when the Fed regained more independence in Binder’s historical episode Inflation uncertainty measure history: Monthly since 1978 - Binder’s proxy for uncertainty derived from rounded survey responses

Pivotal Quotes: "inflation pollutes the price signal" — David Beckworth: Used to describe how inflation makes relative price changes harder to interpret "I think the way to do that is not as much through communication as the Fed would hope, but it's more through like actions rather than words." — Kerala Binder: Binder’s view on how the Fed should anchor expectations "I think consumers who expected higher inflation have consumed a little more recently and expect to consume a little less in the future." — Kerala Binder: Summary of her historical Korean War-era expectations-and-spending study

Implications: Listeners should treat consumer inflation surveys as useful but noisy signals. For policymakers, the message is to watch broader inflation components, market measures, and anchoring of expectations—while recognizing politics and gasoline prices can distort consumer sentiment.