Americans’ Inflation Expectations Just Collapsed

When it comes to inflation, expectations matter. A lot.

We’ve all been led to believe that price growth is “always and everywhere” a monetary phenomenon, but I’ve got news for you: If energy bills quintuple because an aging autocrat decides to redraw a border or if consumers become convinced that economy-wide prices are set to spiral out of control, your textbooks and formulas won’t much matter. If there were just a handful of genuine US dollars in existence but nobody thought they were worth anything, what would they be worth? Exactly.

That’s why restoring institutional credibility is paramount for the Fed in 2022. They could metamorphose, overnight, into a cruel gang of super-hawks bent on restoring Coca-Cola prices to a nickel and it wouldn’t make a dime’s worth of difference if the public isn’t buying it. Either the Fed is a credible institution and the dollar a viable currency in the estimation of economic actors, or they aren’t. If they aren’t, the rest is irrelevant. The dollar, like all fiat money, is a shared myth. The second people stop believing it, it collapses, irrespective of how “responsible” or “respectable” your favorite monetary aggregate or ratio looks on paper.

With that in mind, there was good news on Monday: Consumer inflation expectations fell sharply for the second month in a row in the New York Fed’s closely watched survey. Median three-year-ahead expectations dropped to just 2.8%, which looks a lot like “normal” (figure below), assuming anyone would recognize “normal” if they saw it.

One-year-ahead expectations were 5.7%, the first reading below 6% since January. The degree of “disagreement” about the short-term outlook hit a new record.

The drop in median one-year expectations for consumers under 40 years old was dramatic. In July, that cohort saw inflation running 6% over the next year. A month later, their outlook was a far more benign 4.6%, the lowest in 10 months.

Broken down by education level, year-ahead expectations have converged across educational attainment to just under 6%. Remarkably, three-year expectations for those with a high school education or less plunged to a series low at just 1.7% (figure below).

For the “some college” group, August’s 2.5% reading matched a record low.

Another notable from the demographic breakdown: The median three-year expected inflation rate for those making below $50,000 per year and for those making between $50,000 and $100,000, are now below 3%. And materially so. For the $50,000 and $100,000 cohort, the 2.4% reading on the medium-term outlook for price growth nearly matched a record low. The same was true for the lowest income cohort, but it’s less notable given the historical prevalence of comparable readings, even as the decline from recent highs was dramatic. For those making $100,000 or more, the median expected rate of price growth over three-years was 3% in August, unchanged from July.

A query begun on an ad hoc basis this year and first published over the summer which asks about consumers’ five-year inflation outlook, showed expectations declined to 2% from 2.3%.

As you can imagine, quite a bit of the relief in August came courtesy of plunging gas price expectations, which fell to zero (figure below).

Consumers’ outlook for food prices also dropped substantially, to 5.8%, the lowest since April of 2021. That’s still more than a full percentage point above the longer-term average, but it’ll work, at the risk of lapsing into colloquialisms.

Expectations for home price gains collapsed too. At 2.1%, the median expected price change has only been lower five other times: In March, April, May, June and July of 2020. So, outside of the initial pandemic shock, August’s reading marked a record low (figure below).

Home price expectations have fallen by nearly two-thirds since April, the New York Fed noted. The one- and three-year point predictions were 4.1% and 3.6%, respectively.

Outside of the decline in property price expectations, I suppose you could write most of this off to the drop in pump prices, which may or may not hold. But, coming full circle, expectations matter when you’re battling to contain inflation.

Last week, while engaging in a somewhat contentious chat with the Cato Institute, Jerome Powell said the Fed was running out of time. “It’s very important that inflation expectations remain anchored,” he said. “[The] clock is ticking. The longer inflation remains well above target, the greater the concern that the public will start to just naturally incorporate higher inflation into its economic decision making.”

In that regard, the New York Fed survey was good news. I’d also note that it has a long and storied history. The poll dates to 2013, roughly a century ago, a time when iPhone iterations were still in the single-digits, Elon Musk was worth less than $10 billion and Dennis Rodman joined Omarosa Manigault and Lil Jon on the sixth season of Celebrity Apprentice.

Those were the days.