Americans believe high inflation is the new normal
Despite a pullback in inflation over the last year, Americans do not appear to be snapping back into their pre-pandemic comfort that low, stable inflation is the normal state of things.
Why it matters: Inflation expectations can be self-fulfilling. To the extent Americans view elevated inflation as a long-term condition, it could make it more likely to come true — or require the Federal Reserve to undertake more painful action to overcome inflationary momentum.
Driving the news: On Friday, the University of Michigan released its preliminary consumer sentiment survey for November. It showed Americans expect 3.2% annual inflation from five to 10 years from now, the highest since 2011.
- Data out from the New York Fed on Monday morning does not show the same dramatic uptick in recent weeks as the Michigan survey, but continues to point to more inflationary consumer psychology than prevailed pre-pandemic.
By the numbers: Americans expect 3.6% inflation over the next year, according to the Survey of Consumer Expectations. That's way down from 2022 levels but has basically leveled off in the last four months, hovering between 3.6% and 3.7%. In 2019, that expectation averaged 2.6%.
- Survey respondents' expected inflation over the next five years edged down to 2.7% in October from 2.8% in September, but remains higher than it was in the summer of 2022.
- Americans seemingly had greater confidence that long-term inflation would fall back to the pre-pandemic norm in August of 2022 — when 2% was the median long-term inflation expectation — than they do now.
Of note: Despite signs of a cooling job market, survey respondents expected earnings growth of 2.8% next year, down from 3% in September but higher than the 2.4% average in 2019.
Between the lines: The relationship between inflation expectations and actual inflation results is murky. But in theory, at least, people expecting high inflation will push harder for wage increases and be more willing to pay high prices on the expectation they will be even higher in the future.
- They may also push harder in various contractual situations to ensure there are protections against rising prices — union deals with a cost-of-living adjustment being the most obvious example.
- If those forces are deeply entrenched, it could prevent inflation from continuing to march downward to the Fed's 2% target.
Yes, but: In practice, consumer expectations don't do a great job predicting inflation. For example, throughout the 2010s, the New York Fed survey showed Americans persistently expected inflation of around 3% — yet it never materialized, with inflation instead persistently coming in below 2%.
Ordinary Americans answering surveys is one thing. It's also worth looking at what professional forecasters — as well as bond traders with billions of dollars on the line — think.
State of play: The consensus view of economists does include an upward shift in the long-term outlook for inflation compared to pre-pandemic, though not as dramatic as the one seen by the masses in surveys like those from the University of Michigan and the New York Fed.
- According to the Survey of Professional Forecasters, conducted quarterly by the Philadelphia Fed and released Monday morning, the median forecaster saw PCE inflation of 2.5% over the next five years.
- That number averaged 1.9% in 2019.
- The median forecaster saw that inflation measure falling further, to 2%, for the period 10 years from now.
The bond market shows less alarm than that about the inflation outlook, with the gap between yields inflation-protected and regular securities implying 2.3% annual inflation over the coming five years.
- However, that is based on the Consumer Price Index rather than PCE inflation. CPI runs higher than PCE inflation.
- Bond prices imply 2.36% CPI inflation in the period five to 10 years from now.
The bottom line: Financial markets imply a return to inflation near the Fed's target is imminent. Professional forecasters are less optimistic on that front. And ordinary Americans aren't buying it.
Editor's note: The story has been corrected to reflect that the median forecasted inflation is 2%, not 2.2%, and fixes an incorrect timeline in the chart to reflect the next 10 years, not the next 5-10 years.