anchored perceived inflation

More on Consumers' Inflation Forecasts by Robert Waldmann

My http://angrybearblog.com/2014/07/anchored-perceived-inflation-or-how-fox-news-helped-obama.html has received more attention than I would have guessed. This should be a semi-serious post on the topic.
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In any case there is clear evidence that a sudden drop in the price of petroleum does not cause respondents to forecast extremely low inflation in the future. In constrast sudden increases in the price of petroleum correspond to unusually high forecast inflation.
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Only later and less dramatically is there the genuinely puzzling anomaly. Median forecast inflation was consistently higher than lagged inflation for the past two and a half years. This is suprising.
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It is not. Using all the Michigan survey data, this coefficient is almost exactly zero and, in fact, slightly positive. There is no evidence that survey respondents place more weight on food and energy prices than on other prices.

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The indicator for 2009 and later is strongly significant and corresponds to forecast inflation being higher than expected by about 0.85%.

This is not a huge anomaly, but it is quite important. Some prominent economists feared that the extremely slack demand at a time of already low inflation would cause deflation. The fact that inflation has continued with high unemplyment suggests that at extremely low inflation rates, expected inflation ceases to affect wage bargains. The idea is that actual reductions in dollar wages are avoided. With normal pressures for variation in relative wages, this means that some nominal wages increase. This is a very old story. The continued increase in hourly wages at a an annual rate varying from about 1% to about 2.5% can be explained this way.

However, it is also possible that high unemployment has caused workers to accept a fairly rapid decline in subjectively expected real wages on the order of one to two percent a year. The systematic over estimate of future inflation would mean that this corresponds to puzzlingly stable achieved real wages.

Now that I am being semi-serious, I have to admit that I can’t determine the cause of the anomalously high forecasts since 2009. In 2009 itself it is not easy to guess the effects of the then recent extreme fluctuations in the price of petroleum. More generally many things have changed. My first guess is that the combination of a Democrat in the White House and fully developed Fox News leads to high inflation illusion. However, I could fit the anomaly very well using an indicator of unconventional monetary policy — say the ratio of total Fed liabilities to GDP. It is certainly true that prominent commentators predicted that the huge expansion of high powered money would cause high inflation. There is no way to know if they would have made the same prediction with a Republican in the White House.

When discussing the effects of unconventionally monetary policy through expected inflation (the Krugman-Woodford story) I have been very skeptical for two reasons. First huge interventions were associated with tiny changes in bond prices (often of the wrong sign). Second the expectations which matter are not those of bond traders but of house builders. Bond traders pay obsessive attention to the FOMC of the Fed.

I now think these two criticisms might cancel out. Bond traders also look at official measures of inflation. This doesn’t mean they think the indices are good or correspond to the cost of living. They do this just because the Fed looks at those indices. However, this may mean that stories about how loose monetary policy is causing high inflation might have more effect on economic agents other than bond traders. This means that the loose money might have caused higher investment through lower subjective expected real interest rates even if it didn’t bring inflation up to target.