The Times Australia
The Times World News

.
The Times Real Estate

.

Inflationary psychology could make things worse, but for now it's in check

  • Written by Meg Elkins, Senior Lecturer with School of Economics, Finance and Marketing and Behavioural Business Lab Member, RMIT University
Inflationary psychology could make things worse, but for now it's in check

With the world is experiencing inflation levels not seen since the 1980s, central banks are caught between warning of the dangers of an 1970s-style inflationary spiral, and contributing to that spiral by talking about it.

It’s a problem in any part of the economy where expectations shape outcomes.

On one hand, central banks including Australia’s Reserve Bank say they fear the return of “inflation psychology[1]” – in which expectations of high inflation drive high inflation.

The Bank of International Settlements (the central bank for national central banks) warned in its 2022 annual economic report[2]:

We may be reaching a tipping point, beyond which an inflationary psychology spreads and becomes entrenched. This would mean a major paradigm shift.

Such warnings, known as “open mouth operations[3]”, are part of a central banker’s policy toolkit, the hope being that people will heed the threat and moderate their spending, negating the need for the painfully blunt instrument of hiking interest rates even more.

On the other hand, the very notion of inflationary psychology is bound up in people being emotional, and not necessarily susceptible to “rational” persuasion.

Read more: 1970s-style stagflation now playing on central bankers' minds[4]

As behavioural economists, we can see the dilemma in warning about inflationary psychology, given the very concept is about self-fulfilling prophecies.

The inflation we are facing is real, caused mainly by supply shortages due to COVID and Russia’s invasion of Ukraine.

It is how we respond to them that either fuels or chokes further inflation.

Cognitive illusions

Behavioural economists know that whereas rising prices needn’t be a problem so long as all prices (and wages) are climbing at the same rate, we notice nominal stated prices much more than we notice real (inflation-adjusted) prices.

In the 1920s, US economist Irving Fisher dubbed this “the money illusion[5]”.

Nobel Prize winners Akerlof and Shiller[6] have demonstrated that the phenomenon is widespread.

Even professional decision makers behave as if nominal prices matter most. Loan contracts, for example, are usually not indexed to inflation, meaning the real value of what’s owed usually shrinks.

Selective perceptions

Focusing on nominal rather than real values gets entangled with selective perception. We focus on what matters most to us, so we mainly consider the prices (and wages) we are familiar with.

This is demonstrated by behavioural experiments showing women are more likely to focus on the price of milk and men on the price of beer and fuel[7].

Clinking beer steins
Inflation perceptions are influenced by changes in the prices of things we are most famiiar with. Matthias Schrader/AP

Another cognitive bias is the availability heuristic[8] – the mental shortcuts we make to assess the probability of future events.

This phenomenon was first identified by Israeli psychologists Daniel Kahneman and Amos Tversky. People tend to exaggerate the likelihood of events they find easy to imagine - such as being killed by a shark.

So much talk about the threat of inflation, and powerful images of hyperinflation - such as people wheeling wheelbarrows full of cash - can similarly influence people’s expectations.

Germany children playing with banknotes rendered valueless through hyperinflation, circa 1919.
German children playing with banknotes rendered valueless through hyperinflation, circa 1919. Albert Harlingue/Roger Viollet/Getty Images

Inflation psychology missing

So far, there’s not much inflation psychology in Australia.

Typically the Melbourne Institute’s survey of inflation expectations has come up with an annual rate of about 4% at times when actual inflation has been about 2%.

Recently, expectations have climbed with actual inflation to peak at 6.7% when actual inflation was 6.1%.

Since then, in July and August, inflation expectations recorded by the survey have declined, to 6.3% in July and 5.9%[9] in August.

Actual inflation versus expectations

ABS and Melbourne Institute Survey of Consumer Inflationary Expectations[10] Taken literally, this means Australians expect inflation to fall. More confidently we can say that consumers’ expectations are in line with reality, rather than above it as has traditionally been the case. The world would be a much easier place for central banks if people were rational. They are not, but for the moment (based on what they are saying) they don’t seem to be getting carried away. Read more: Australia's inflation rate is to go monthly. Be careful what you wish for[11] References^ inflation psychology (www.rba.gov.au)^ 2022 annual economic report (www.bis.org)^ open mouth operations (www.rba.gov.au)^ 1970s-style stagflation now playing on central bankers' minds (theconversation.com)^ the money illusion (www.goodreads.com)^ Akerlof and Shiller (reflections.yale.edu)^ beer and fuel (www.pnas.org)^ availability heuristic (thedecisionlab.com)^ 5.9% (melbourneinstitute.unimelb.edu.au)^ ABS and Melbourne Institute Survey of Consumer Inflationary Expectations (melbourneinstitute.unimelb.edu.au)^ Australia's inflation rate is to go monthly. Be careful what you wish for (theconversation.com)

Read more https://theconversation.com/inflationary-psychology-could-make-things-worse-but-for-now-its-in-check-188723

The Times Features

How to Treat Hair Loss Without a Hair Transplant

Understanding Hair Loss Hair loss can significantly affect individuals, both physically and emotionally. Identifying the causes and types can help address the issue more effecti...

How to Find a Trustworthy Professional for Your Plumbing Needs

Nowra is an idyllic locality often referred to as the city of the Shoalhaven City Council in the South Coast region of New South Wales, Australia. This picturesque suburb feature...

How to Choose a Mattress for Back/Neck Pain and All Sleepers?

Waking up with a stiff neck or aching back can derail your entire day. If you're one of the millions struggling with chronic pain, a supportive mattress is more than a luxury – i...

What to Look for in a Professional Debt Collection Service

Often in life, overdue payments are accidental or caused by unusual circumstances. This can cause some temporary convenience, but everything carries on as usual. However, when th...

Be inspired by celeb home decor from across the globe

GET THE LOOK: INDULGE IN THE SAME INTERIOR AS YOUR FAVE CELEBS There is a reason that Denmark ranks the highest on the happiness scale worldwide, one word: Hygge. Hygge. Hygge is ...

Maximizing Space in Narrow Lot Homes: Smart Design Solutions

Urban housing markets continue to push homeowners toward smaller, narrower lots as land prices climb and city populations grow. These thin slices of real estate present unique de...

Times Magazine

The Essential Guide to Transforming Office Spaces for Maximum Efficiency

Why Office Fitouts MatterA well-designed office can make all the difference in productivity, employee satisfaction, and client impressions. Businesses of all sizes are investing in updated office spaces to create environments that foster collaborat...

The A/B Testing Revolution: How AI Optimized Landing Pages Without Human Input

A/B testing was always integral to the web-based marketing world. Was there a button that converted better? Marketing could pit one against the other and see which option worked better. This was always through human observation, and over time, as d...

Using Countdown Timers in Email: Do They Really Increase Conversions?

In a world that's always on, where marketers are attempting to entice a subscriber and get them to convert on the same screen with one email, the power of urgency is sometimes the essential element needed. One of the most popular ways to create urg...

Types of Software Consultants

In today's technology-driven world, businesses often seek the expertise of software consultants to navigate complex software needs. There are several types of software consultants, including solution architects, project managers, and user experienc...

CWU Assistive Tech Hub is Changing Lives: Win a Free Rollator Walker This Easter!

🌟 Mobility. Independence. Community. All in One. This Easter, the CWU Assistive Tech Hub is pleased to support the Banyule community by giving away a rollator walker. The giveaway will take place during the Macleod Village Easter Egg Hunt & Ma...

"Eternal Nurture" by Cara Barilla: A Timeless Collection of Wisdom and Healing

Renowned Sydney-born author and educator Cara Barilla has released her latest book, Eternal Nurture, a profound collection of inspirational quotes designed to support mindfulness, emotional healing, and personal growth. With a deep commitment to ...

LayBy Shopping