How Do Households Respond to Expected Inflation? An Investigation of Transmission Mechanisms,

Abstract

We investigate the channels through which inflation expectations affect household spending by conducting surveys featuring hypothetical scenarios involving an increase in inflation expectations. Most households did not adjust their current spending plans, often because they perceived inflation expectations as irrelevant or adhered to a fixed budget. Among those who did adjust, most decreased their spending, primarily due to wealth effects. Few households increased spending as prescribed by the traditional intertemporal substitution channel. We also document that financial conditions, cognitive ability, and subjective mental models—such as stagflationary expectations—help predict spending responses and the mechanisms households cite. Our findings provide insights into the discussion of using inflation expectations as a policy tool and highlight key frictions to incorporate into theoretical models.