Odd Lots - Why Everyone's Experience Of Inflation Is So Different

Episode Date: July 19, 2021

Inflation is running hot these days. But, even when the official measures were considerably cooler, there were many people who were skeptical and insisted that inflation was running hot and rampant. It turns out, nobody really experiences inflation similarly, and one's own consumption and behavioral patterns will have a big impact on their outlook. On this episode, we speak with Berkeley professor Ulrike Malmendier, whose work has shown how one's behavior (where you shop) and history (what conditions were like earlier in your life) can inform views and perceptions of inflation for years.See omnystudio.com/listener for privacy information.

Thanks for listening to OddLots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, OddLots on Amazon Music. And welcome to another episode of the All Thoughts podcast. I'm Tracy Allaway. And I'm Joe Wisenth. So, Joe, we're recording this episode on July 13th. And we have just 30 minutes ago gotten the latest U.S. inflation data. It's come in a lot higher or hotter than expected. I think headlines CPI came in at like 5.4%. And core inflation was 4.5%. It was expected to be something like 4% for June. And we're sort of watching the reactions come in in real time from the cell side analysts and on social media. And it's amazing how you're getting these sort of two distinct camps.

So on the one hand, everyone's looking at the same data. but everyone seems to be reaching vastly different conclusions. So on the one hand, you have people who say this is still transitory. A lot of the strength is in certain segments that have seen these supply bottlenecks that we've been talking about. And on the other hand, you have people who are saying, well, this is starting to look very worrying and maybe something more permanent. Right.

There's no question that the intensity of the CPI gains that we've seen really over the last three months have been higher, hotter than economists had experienced. It seems to be lasting a little bit longer. So on the one hand, you say, okay, that's worrisome. On the other hand, when you dig into the guts of the report, it still looks like there's an argument for transitory. So a huge component of this is still used cars, which haven't slowed down, you know, not long ago.

We were never talking about used cars as an important inflation category. Now is something like a third of the gain or 40% of the gain was used cars. Other categories specifically related to reopening are, pushing things higher. So I kind of think it's like an impasse. Like no side will be totally satisfied because the people who are convinced that, oh, there's all transitory can point to the subindexes or the sub numbers, whereas the people who are saying this is a start of a real problem, point to the headlines that are hotter than expected several months in a row now. Yeah, it's kind of like CPI is the ultimate exercise in confirmation bias. Like there's something for everyone, whether

you're looking at the headline numbers or the subcomponents. But I mean, I say that. And one of the things I've been thinking about a lot lately is this idea that, you know the saying that inflation is always in everywhere a monetary phenomenon, which I don't necessarily disagree with. But I feel like it's also a human phenomenon. And you're seeing that in this discrepancy between these two camps of people looking at the inflation numbers. And you're also starting to see it in terms of inflation. expectations themselves. So for instance, if you look at the breakdown of survey respondents by age, you can see that older people are a lot more worried about inflation at the moment than younger people, which is kind of interesting. Yeah, I mean, I think instead of, you know, they say it's

always a monetary phenomenon. But look, I don't think there's an obvious monetary link to be drawn between, say anything that the Fed has done recently and the fact that used car prices continue to have this bottleneck in part due to a chip shortage as a result from our overreliance on TSM and the virus and so forth. So, but what I do think and what I think you're getting at too is that there is a tremendous political valence to all inflation. And if you are young and you're able to be flexible in your consumption and lifestyle patterns, maybe inflation doesn't affect you so much, if you're older, if you're on a fixed income,

it could be a greater problem. if you're a urban professional who likes to eat a Chipotle burrito bowls and take an Uber to work, you're probably not thrilled with the cost of an Uber these days and you want the Fed to hike. So a lot of it is sort of like personal. It's formed by one consumption pattern. There's a political nature. And I think these headline CPI numbers that we get, no one feels them like no one's, everyone's like, that's not my experience. Things are up 10%.

Everyone is sort of a subjective experience of what kind of inflation is. happening in the economy. Yeah, exactly. Subjective is the key word. So I'm glad to say that we are going to be getting into the subjectivity of inflation on this episode. And we have the perfect person to discuss it. We have someone who basically wrote a seminal paper on inflation experiences back in 2013, and she's been updating her thesis with new research. And we're going to get into that. I'd like to welcome Orica Malmendii onto the show. She's a professor of economics and finance over at the University of California. Welcome. Thank you so much. I'm excited to be here. We're excited to have you. So we just had the CPI numbers come in. I guess my first question is when you started looking at inflation or at least when you published this paper called learning from inflation experiences back in. 2013, you sort of looked at this issue from a very different angle, from a human experience angle.

And I'm just curious what sparked your interest in pursuing that line of investigation? Yeah, that's actually a really good question. In particular, given that my earlier research was actually not on inflation, but on stock market experiences, the Great Depression and how it, you know, generated this generation of depression babies shying away from the stock market. But truth be told, it was actually inflation that first drew me into that. As you may have detected by now, I'm German and my co-author on that first paper, Stefan Nagel is also German and I remember us talking in the hallways of the university about why the Germans, including us, have always been so obsessed with.

with inflation and had inflation concerns, et cetera, and us tracing it back to that traumatic experience of many Germans of the German hyperinflation. So it was indeed long-lasting effects of living through an inflation and how it affects your beliefs and worldviews that drew me into that. I very much hope we won't have to draw parallels from the current inflation spike. That's interesting. I mean, obviously, I've heard that my whole career, that, you know, you look at German fiscal policies, you look at the official German stance towards the ECB, typically, and it's

always cited exactly what you say, that there is the history, the shared memory of the hyperinflation, which we've talked about on the past episode, and that continues to inform German perspectives on macro policy till this day. And I'd always wondered, like, is that a myth, or is that a just-so story, or is that an oversimplification of things? How much can you expand on that a little bit further? What is the manner via which this traumatic episode of the past continues to inform public sentiment and public policy today? What's the transmission mechanism there? That is an excellent question as well.

And to be really honest, it is a little bit outside of the data I've actually studied. Because I have indeed studied the inflation you have personally experienced and how, say, talking about today's events and you are pointing out that some older generations might be more concerned than some younger ones attributing it maybe to different lifestyles and I would want to make you pause and say no but it also might reflect what they've personally lived through those younger folks might not have a vivid memory of the 1980s so you're quite right to question me about the you know German hyperinflation almost hundred years ago and and Germany has had quite stable price increases price levels throughout the last you know decades so how

Is that possible? Well, increasingly, I am getting deeper into the underlying neuroscience of what kind of events do get deeply engraved in our memory. And transmission from generation to generation can happen. Stories, vivid stories matter. You know what also matters? Media, how much podcast, news organization, social media, etc., are highlighting the inflation will have a big impact on how much this will be engraved in our memory. But here we're just at the beginnings. We're getting to the deep underpinning from neuroscience, synapse formation, and so on as we speak. I hope I have more to say on that soon. So why don't we get into some of your research and talk about what you just pointed out, this idea that there's a difference between people's experiences versus their personal inflation basket. So it might be that older people who are on a fixed income and whose major expenditure or whose major source of revenue comes from, you know, bond payments or something like that. They don't like inflation. They fear it.

But it might also be that they're the ones that remember periods of inflation like the 1970s versus younger people. So I guess I'm curious, like, could you describe that effect in detail? And also, can you describe how you disaggregated those two things in your study? Yeah, happy to do that. So let me start by saying both are at work. work. Both mechanisms you just pointed out differences between your personal inflation, your personal consumption basket and the associated inflation compared to mine plays a significant role and then differences, differences we have made over our lives so far. So starting from the ladder, which some of my research you referred to earlier, builds on, I literally

looked at when people, this is using US data, but we have to. since then done also non-U.S. studies. So I literally looked in the Michigan survey of consumers, when people are born, what has been the inflation over their lifetime so far? And then asked, does that predict the inflation expectations looking into the future? And it turns out, yes, that personal inflation experiences are really powerful. Your lifetime average inflation, so to speak, is really powerful in predicting what you think future inflation will be.

And this is just taking aggregate inflation experiences. So we are not yet at those personal consumption baskets. Now, just to complete the picture here, economists would immediately say, well, you know, these might be information asymmetries. I'm not reading, you know, the back page of the economist or not following as much as you guys, the new CPI numbers coming out.

And so this just reflects that I'm not aware of it. Well, what I'll then like to do is to point people to our study of FOMC members, right? The Federal Reserve Bankers who have all the data are at their fingertips and even for them personal experiences,

just taking their birth year, calculating their lifetime average inflation experience in the aggregate is really powerful in predicting their semi-annual forecasts of inflation to Congress. So that's at work. And then the second point

is definitely also at work if I am able to get exactly your consumption basket or let's take a big chance of it. Let's take your grocery shopping and look at inflation that occurs in there. It has significant influence on your predictions about future inflation. So cool fact here is that for years we've known that women tend to be more pessimistic. So they have higher inflation expectations. Federal Reserve bankers have known that for years. I've always wondered why the women are so

anxious about inflation. Well, it turns out that if you control for grocery shopping, so traditional, you know, gender roles, woman does the grocery shopping? shopping, it takes the whole gender effect away. So it just comes from groceries being so volatile, people anchoring on the price hikes. That explains all those gender differences. So this is, I think, a powerful example for your second point. What about gasoline? There's a, I hear people often say that people form their views on inflation at the pump. Yes, indeed. So we also see that in our data. Other people have found that in their data. You know, my dream scenario is still one where I get subjects to put on, you know,

Google Glass or something like this. I can literally see all the prices they look at all day long. And I think we would get a really, really good picture of what their inflation beliefs are currently. So we have been focusing on grocery prices because there's fantastic detailed data on it. We have some data on gasoline. If you combine the two, it becomes even more powerful. So one of the things I've always wondered is, and this might sound like a weird question, but bear with me, but the degree to which inflation expectations actually matter and whether or not people do or do not change their behavior based on their future expectations of inflation. And for people like, I guess Joe and myself, certainly for our professional lives, we've experienced pretty low rates of inflation. And so it's hard to conceptualize a moment. in time where if inflation were to spike, what would our consumer response actually be to that?

Like, I have no basis for comparison, so it's really hard to imagine. I'm just wondering, what's your take on that? Do inflation expectations actually impact behavior? Yeah, this is a question I get not only from, you know, folks working in the media or even outside academia and media, but even within academia, we are often asking ourselves that question. I often get that in referee responses to my papers. And it's a very reasonable question. Of course, traditional economic models would say, oh, yes, it will affect your savings

decision, including your retirement saving. It might affect your consumption choices, right? Inflation goes up. We should all be spending like crazy because money will be worth less in the future. And that's not quite what happens. So I just want to pause for a moment and say that the standard economic models in academia, but also in the policy world do implicitly assume there's a strong link. And so that goes into all of our policy recommendations.

So the baseline assumption is there, but is it actually true? Well, if we look at decisions of people who literally deal with inflation, so as I said, I'm studying FOMC members, members of the Federal Open Market Committee who decide about interest rates and react to the inflation they see, and unemployment rate, et cetera, I do see it working there. So for starters, among the professionals, the effect is there that they're overly influenced by their personal experiences and are voting to dissent, say, from the chairperson's proposal if, you know, their personal experiences point them into a different direction.

Fun fact, also, I got some data from one of the big financial firms working in bonds, and there too, I got also their nationality inflation. the French and the Germans and the many Americans working there, their personally experience affects their beliefs and will absolutely influence their decision making in the firm. But I think ultimately your question was more targeted maybe to, you know, the person like you and me who's not necessarily like actively trading or making policy decisions based on inflation numbers.

And it is a good question. It is to a large extent an open question still to be shown how it affects, say, wage negotiation, labor market. choices, et cetera. But what I can say is that, well, not surprisingly, personal inflation experiences affect your beliefs about future interest rates. So, you know, inflation and nominal interest rates are closely linked. So it shouldn't come as a big shock. But only recently we've been able actually to get the data to formally show inflation experiences strongly affect in not only inflation beliefs, but correlated with that, also nominal interest rate beliefs.

And then those in turn affect some of the financial. the biggest financial decisions households make, namely whether to buy or rent a home and conditional on buying, whether you take a fixed rate or variable rate. So the generations who have had experienced, for example, the big hikes, end of the 1970s, 1980, who were really afraid of that happening again, they love fixed rate mortgages. I think the shadows of that are still present. And they are foregoing lots of money by not using cheaper variable rate mortgages when available. So here I would say we do have some first evidence. Yeah, I feel like even the children of that generation has been like sort of like taught that fixed rate mantra.

So it's like even for myself and I own a house, just like the idea of like, you know, all I've experienced all my life basically is lower and lower rates. But still the idea of like 30 year fixed rate being the most responsible thing to do feels very that that feels like a very powerful force exerted on me. Okay, you find these cohort effects where there's sort of these clear links between the experience that someone had, whether it's on interest rates, whether it's on inflation and their personal behaviors. To what degree should policymakers internalize them? Because we know, like, from the Fed perspective, they put a lot of weight on inflation expectations. And they often ascribe mythical powers, it seems like, to the public's inflation expectations and the importance of keeping them so well anchored. But if inflation expectations are so subjective and so heterogeneous across different parts of the population by age, demographic, experience, and so forth, how much power do they really have as an economic force? I think that goes back to the previous question to some extent.

I think the Fed should continue to spend a lot of time on figuring out how these inflation expectations actually translate into economic decision-making and how our, standard economic models are actually wrong in many respects. So I'm totally with you in questioning that. However, I would not say that, oh, because they're so heterogeneous, we should throw up, you know, throw our hands in the air and say, well, what can we do here? This mythical representative agent whom we are targeting doesn't exist. You used the word cohorts before. And I think that's a good clue. Certain cohorts have experienced, say, the 1970s, 1980s. high peak inflation. Others haven't. And that comes with different ages. So it's the younger generation, as you are saying in the intro today, which is less concerned about this inflation. And that's the

generation that will likely be borrowing and going for the new houses. So the older generation is instead the one that's providing this liquidity in the market. So where do we see the shortage right now? what do we want to encourage, who's looking for jobs, you know, rather than saying, oh, we actually target this median investor or a median consumer or saying, oh, we can't do anything because it's so heterogeneous, thinking by cohorts, thinking by where the needs are, the unemployment concerns, et cetera, I think is the way forward. I mean, again, a related question, but do you think that policymakers actually look at demographics when they're looking at inflation expectations,

like to what degree do you think they're trying to break down an inflation survey by subjective experience? Well, I don't work in the policy world, although I enjoy the interactions. I don't want to give the completely oversimplified impression that nobody is looking at breakdowns by age. I mean, you guys started today's podcast that way,

and I know people are highly aware of that as well. Well, in terms of accounting for where these people come from, what their experience has been, and therefore what their fears are likely going to be, I personally think they are still too little. So there is some aspect of looking by age, as you are pointing out, but then we tend to attribute everything to age-specific, life-cycle-specific effects. Oh, the older generation, investing more in bonds, consuming out of bond income, etc. No, but it matters whether that older generation lived through the 1980 peak or not is kind of where I would like to push things towards.

Why is inflation so political? I mean, there's many ways to measure the economy. And there's numerous data points to sort of get fields for the forces and pressure is exerted on the economy all the time. Inflation is one, obviously, employment is another. We get fresh data points every day. there's something about inflation that captures people's imagination. It makes people angry. People form full identities out of their stance on inflation.

In your work, do you have any insight into what it is about this particular number that sets people off? This is so interesting because as a German, I would think, oh, it's so much less political in this country compared to where I'm from, right? So, I mean, in Germany, definitely the tabloid would have as headlines. discussion about inflation policies of the European Central Bank and why they disagree with those. So that's a really interesting perspective already. But nevertheless, I think you are right. It's a pretty technical measure and it does play a fairly large role. Nevertheless, I don't have

research on that. My personal suspicion from having worked a lot with the data, having read a lot is it has this aspect of making assets, certain assets you own, potentially less valuable, while others not. It generates some kind of inequality in how much people are affected by the outcomes of a crisis. So people holding real estate gold stock are less affected than others. And I think that sometimes triggers an additional degree of these tensions. But yeah, I'd be curious to find out what others think. I wanted to talk about some of your recent work as well. And you've been applying a lot of the things you've learned in this 2013 paper to policymakers themselves.

And I think this is absolutely fascinating because in your latest work, I think you found that FOMC members' personal experience with inflation affects their expectations for inflation so much so that you can actually kind of predict where they're going to go better than some more traditional forecast methods. So could you maybe walk us through that and also how you got the idea to look at this particular topic? Well, to be completely honest, what had been irking me is that economists, and I think to some extent, also people working in the policy world, had been, very fast to attribute any kind of experience effect, to use the term we've coined, to informational asymmetries. So as I stated earlier, if somebody who has lived through the German hyperinflation or the

high inflation in the 70s, 1980 in the U.S., if that person tends to be more pessimistic about future inflation numbers being rather high, then in, in, context, is quick to jump to the conclusion that their informational frictions, not everybody has all the information data at their fingertips. Hence, those personal experiences is just data we are aware of. And that explains why personal experience affect your beliefs. To draw a finer distinction between your personal experiences affecting you so strongly because they're differently anchored in your brain versus, oh, without experience, you just don't have the knowledge. You're not aware of it. I was really drawn to the idea to basically hone in on the experts, on the

people as far as I imagine, you know, the FOMC members' lives, they have on their desk in front of them, all the inflation numbers, anybody would ever want to see. There's no informational asymmetry whatsoever. And now they're ready to run and make forecast about future inflation. And so to show even for those experts that they are strongly affected by their personal experience, is what really drew me into that topic. But what were the actual findings? Because I found the link that you found between members' personal inflation history and sort of predicting or forecasting how they might react to monetary conditions.

That was really striking. So the first step is simply to relate personal experiences to their forecast. So as you probably know, FMC members twice a year make these forecasts to Congress about what they think. Inflation will be over, you know, various horizons. They say one year I had horizon under, you know, their ideal policy. And if you plot what members say in these in these semi-annual forecasts against their personal experience, normalized, you know, you want to account some word forward for what year we're in,

etc. So we normalize by what their staff told them in the green box. normalized by the staff forecast, you get the most beautiful scatter plot of like strongly correlated personal experience and what they say. So that was interesting. Now you go to the actual voting behavior. And I was a little nervous of doing this analysis. I mean, one thing is to look at 100,000, millions of U.S. consumers and their inflation

expectations and how they maybe choose their fixed versus variable rate mortgage, where I have a lot of variation in ancient experience. versus, you know, even at this day and age, pretty much somewhat older male, white members of the FOMC. But luckily, there was some heterogeneity. And what we found is that if you look at even relatively small about one standard deviation increase in personal experience, point one, sorry, percentage points increase in personal inflation experience relative to the overall group, that does have significant predictive power for your voting behavior. So for your actual, you know, dissent to the chairperson's proposal in terms of what should happen and to interest rate.

And as you know, in the day and age, dissents have become less common, less frequent. There was a bit of a break. But so if you look, for example, at the overall frequency in the data of a dovish descent, it's about, you know, 2.5 or something, probability. But if I increase your personal and inflation experience by about one percentage point, the probability goes down by about a quarter and the exact reverse is true for

hawkish descent. So that probability is somewhat higher, about 4% of, you know, FMC members are willing to dissent. But if I shock you, I mean, I make you a person that's born at a time with somewhat higher inflation experience, 0.1 percentage point, your quarter or third higher probability of dissenting with the forecast. So it has actual impact. You might not turn around the ultimate vote, but it does leave a, you know, it is a statement. It's seen by the market. It might influence the next proposal the chairperson would be making.

I do have, if you're interested in, it's a very cool anecdote to add about a German guy. Okay, so there is this guy born as Heinrich Wallich in Berlin, in Germany, 1914, into a family of bankers. He actually lived through Germany's hyperinflation in 1923, the family emigrated to the US in the 1930s where he became economist and was a Fed governor from the mid-1970s to mid-1980s. And by then, you know, Henry Wallach rather than Heinrich Wallich, but was a, you know, very well-regarded member of the Fed. And to the best of my knowledge, she still holds the record of dissents. He dissented 27 times during his tenure on the Fed.

the Federal Reserve Board, which is the highest number of dissent among all FMC members. And as you can imagine, he was very much into the hawkish direction, always telling everybody that they don't understand how this can happen and what the implications are, et cetera. And clearly this is a super smart person. He knows he's in a different country, in a different monetary system. He's in a vastly different decade right now. And still, he couldn't shake it. And that experience just stayed with him.

I guess I have a sort of like very big picture question as someone who looks at the intricacies of inflation and how they relate to individual groups of people. What's your take on the current environment? And I realize you're not a market watcher, but we did just have CPI come in much hotter than expected. You mentioned the idea that the more the media talks about inflation, the more people see articles. or other people discussing it, the more it sort of feeds into inflation expectations themselves. Would you expect this to become a sort of self-fulfilling cycle? That is a very good question. Currently, I happen to still be in the camp,

which is watching how different unusual components of the inflation basket. Joe mentioned the used car market, for example, are having an over-proportional influence. Given all the supply and demand disruptions due to COVID-19, which is kind of trying to get into kind of a smoother flow again, I'm personally thinking there are lots of frictions, which are having influences right now. So I'm currently still thinking that things will, you know,

have to be looked at again in a couple of months. But obviously, in particular, with all these support, government support, there is a real concern. Going back to the theme we had in the beginning, I do think that if this remains the main new story over the next month, it might end up accelerating in terms of the impact on people's anchoring in memory and the vividness and how much they are taking into account. If instead other things, positive or negative, you know, talk about the delta variant, et cetera, are starting to dominate the news cycle. I would expect this to have a less long-lasting effect on people's inflation fears and economic decision-making.

I think that's probably where I currently stand. All right. Well, Orica, a fascinating conversation. And I really do urge anyone listening to check out some of your research on the topic. As we enter this very, very heated, well, we're already in it, this very heated period of discussion over the future of price increases. Thank you so much. You're welcome. This was really fun.

Thanks for having me. Thank you. That was great. Yeah. Appreciate it. So, Joe, I found that conversation really, really interesting. And again, at a time when we have this sort of polarized perception of the future of inflation, it's really nice to dig into some of the details behind how people are actually thinking about this topic.

Yeah, I thought that was super interesting about like even FOMC members. You could sort of anticipate their own policy actions simply based on their own experiences, their lived experiences with inflation. And I think that goes a long way in explaining why this one number is like such a lightning rod. Like everyone has different experiences with pricing. Everyone has different consumption baskets. Everyone has different periods where interest rates affected them negatively or positively in one way. And it's the way people like carry through that for years is really profound.

Yeah. I mean, to your point, I think at the beginning of the discussion, everyone sort of either benefits or loses out from different price movements. And there are so many of them and so many factors at play that it's sort of difficult to disaggregate them all and also difficult to come up with, as Ulrico was saying, this sort of mythical representative inflation survey respondent. The one other thing I thought was really remarkable in there was this idea that, gender differences in inflation perceptions could be knocked down so quickly just by eliminating grocery shopping. I had no idea that that effect was so pronounced. That was really interesting. And then you wonder, it's like, okay, who gets gas more often because you hear that gas is often a big factor. But it really does like think like if you listen to like Jay Powell, they're putting so much emphasis on these so-called like inflation expectations or the importance of keeping expectations anchored and so forth. But then you look at like, well, what are the foundations of these inflation expectations that are supposedly so important to policy? And it seems so like

arbitrary and subjective in many cases, like where they were formed. And so on the one hand, maybe they're powerful, but on the other hand, like, well, we're certainly putting a lot of weight on some things that are like very nebulous and random. Right. And quite disparate at that. All right. Yeah. Shall we leave it there? Let's leave it there. Okay.

This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Allaway. And I'm Jill Wisenthall. You can follow me on Twitter at the stalwart. Follow our guest, Urike Malmendii. Her handle is at Umalmend. Follow our producer, Laura Carlson.

She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. and check out all of our podcasts at Bloomberg, under the handle, ad podcasts. Thanks for listening.