Memories of (dis)inflation

It’s by now a well-established finding that lifetime experiences of inflation shape our attitudes toward inflation and financial decisions more generally. However, Isabelle Salle and her colleagues used surveys among Dutch households to highlight a fine but important difference in how we all form our expectations for future inflation.

It is one thing to live through periods of higher or lower inflation, but it may be a completely different thing how we recall these episodes from memory. What seems to drive our expectations for future inflation seems to depend crucially on the kind of inflation episodes we recall from memory and how we recall them.

The researchers noted that not all the participants in the survey recalled the same inflationary episodes. Even if they were roughly the same age, they did not necessarily recall the same inflation episodes. For older people, the 1970s inflation loomed large in their memories, but for younger people who did not live through these extremes, memories became blurrier with some remembering the inflationary period of the mid-2010s, others focusing on the inflationary period in the run-up to the financial crisis.

Similarly, when asked about disinflationary periods, people tended to recall different episodes of falling inflation but in general had a harder time remembering periods of falling inflation than periods of rising inflation.

And that last point has important consequences for how people form their inflation expectations. The more people remembered disinflationary periods in the past, the lower their inflation expectations for the future were. Simply remembering more episodes of declining inflation also did the trick, not just remembering how much inflation dropped. Finally, the less certain they were about their memories of inflation the lower their inflation expectations for the future.

What this tells us is that people form their expectations based on salient experiences, not objective experiences. And that means that how we remember the 2022 inflationary episode (and how this episode shapes our financial decisions) is not yet determined. If inflation declines relatively fast, more people will tend to remember the disinflation of 2023 and 2024. This, in turn, will reduce the inflation expectations of households and change their behaviour. However, if inflation does not drop to 2% or lower fast or if inflation remains elevated because central banks cut interest rates too fast too soon, memories of disinflation will not be very strong while the memories of the inflationary spike in 2022 will persist. With possibly very different results for household behaviour.