Board of Governors of the Federal Reserve System

January 19, 2024

Inflation Perceptions During the Covid Pandemic and Recovery

David Lebow and Ekaterina Peneva

Since 2016, the Michigan Surveys of Consumers (MSC) have included questions on inflation perceptions—what people believe inflation to have been—that are worded symmetrically with their long-standing questions on inflation expectations. The questions on inflation perceptions are currently posed four times a year—in February, May, August, and November. Using available data at the time, Axelrod, Lebow, and Peneva (2018) concluded that inflation expectations and perceptions are very similar and that if perceptions were to change, expectations were likely to change as well.¹

In this note, we focus on the behavior of inflation perceptions and expectations since the Covid pandemic began, based on data through November 2023. Our main findings are:

1. The central tendency of inflation perceptions suggests that households recognized, with surprising accuracy, the timing and the magnitude of the initial run up in in inflation.
2. However, perceptions of 12-month inflation continued to increase past the peak of actual inflation. Inflation perceptions have been coming down, but more slowly and from a higher level than actual inflation.
3. Inflation expectations, especially over the longer-term, have remained well below perceived inflation; that is, households expect the high inflation observed over the last few years to be transitory.
4. Median inflation perceptions have differed notably for people with different self-identified political party affiliations, while differences across demographic groups have been relatively small.
5. A strong negative correlation between inflation (both actual and perceptions) and consumer sentiment re-emerged during the pandemic recovery.

I. Time series results for inflation perceptions and inflation expectations

The Covid-19 crisis and its aftermath, including the policy responses, led to enormous changes in inflation. Prices for many items—especially gasoline, clothing, transportations services, and accommodations—fell during the sharp economic downturn in March and April of 2020, while prices of some other items—especially food at grocery stores—posted unusually large increases at that time. On net, the dominant pressure on inflation was clearly downward at the beginning of the pandemic. In the spring of 2021, however, prices for some items turned up sharply, and by the fall of 2021 the price increases had become widespread. By 2022, inflation had risen to levels not seen in 40 years. Inflation then began to recede and declined throughout 2023.

Before the pandemic, the MSC median household perceptions of 12-month inflation were about in line with published CPI inflation (Figure 1).² At the start of the pandemic in the spring of 2020, the median 12-month perceptions ticked down but did not fall as much as actual inflation did. However, as inflation started trending up in 2021, households were quick to update their perceptions, and they did so remarkably accurately and quickly (judging by the median response) through early 2022.³ And as with actual inflation, 12-month inflation perceptions declined through 2023, though with a lag: Median inflation perceptions moved somewhat higher than CPI inflation, reaching 10 percent in late 2022, and perceptions have remained above published inflation since then even as they have been coming down. In the latest reading, for November 2023, the median respondent perceived inflation to have been 6.4 percent over the past year, well above the 3.1 percent change in the headline CPI over the twelve months ending in November.⁴

Figure 1. Short-term Median Inflation Perceptions and Actual Inflation

Some findings from the recent literature on inflation perceptions and expectations may be relevant for understanding why inflation perceptions increased in line with actual inflation but are falling more slowly. For example, when people base their responses on their personal experiences, they both are more likely to focus on extreme price changes and tend to recall price increases more readily than price decreases (e.g., Bruine de Bruin et al., 2011, 2012, Jungermann, 2007). More recently, for example, D'Acunto et al. (2021) argue that grocery shopping explains the finding that women tend to have persistently higher inflation expectations than men. The authors argue that because grocery prices are volatile and positive price changes are especially memorable, women (who traditionally do most of the grocery shopping) end up having higher inflation expectations. During the covid pandemic and recovery, the size and especially the frequency of positive price changes increased (see Montag and Villar, 2023), inflation became widespread and was intensively covered by the media. In other words, all consumers were exposed to broad-based positive price changes, which likely explains why we do not see notable differences between the median perceptions of the various demographic groups. The broad media coverage of the bad inflation news likely also contributed to the accurate increase in the median perception. At the same time, since media coverage tends to follow negative economic conditions more closely than positive conditions (Goidel and Langley, 1995), it may be contributing to the sluggish decline in perceptions. Indeed, over the past year, with falling inflation, fewer households mention bad news about prices in the MSC but even in the most recent surveys, consumers mention bad news about prices more than good news (Figure 2).⁵ The ongoing prevalence of unfavorable news heard about prices might also reflect the fact that while the rate of inflation has come down, people are not seeing and hearing about declines in the level of prices.

Figure 2. News Heard about Prices

As with inflation perceptions, median short-term inflation expectations turned up in 2021 and moved lower on net over 2022-23 (Figure 3). However, since early 2021, 12-month perceptions have been much higher than 12-month expectations, indicating that households were viewing the elevated inflation during and after the pandemic as transitorily high and did not expect such high inflation readings to be repeated.⁶ Meanwhile, long-term inflation expectations have remained well below short-term expectations, further indicating that the high inflation was expected to be transitory. Median inflation expectations over the next 5 to 10 years only edged up during the covid recovery, and while they remain slightly elevated relative to their level in 2016-19 they have remained within the range seen in the 2000s, when inflation was running around 2 percent.

Figure 3. Median Inflation Perceptions and Expectations

While the median short-term perception was running a little below the median long-term perception prior to the pandemic (Figure 4), it is has been running much higher than the median long-term perception for the last few years, indicating that households clearly realize that inflation over the past few years has been unusually high by recent historical standards.⁷

Figure 4. Median Short- and Long-term Inflation Perceptions

II. Inflation perceptions across demographic groups

Figure 5 shows median 12-month inflation perceptions separately for various demographic subgroups. By far the largest differences in perceptions have been across people with different self-described political affiliations. From 2017-20, when the President was a Republican, Republicans perceived inflation to be lower than Democrats did. But since inflation rose in 2021, when the President was a Democrat, Democrats perceived inflation to be notably lower than Republicans did, with Independents in the middle (but closer to Republicans most recently). This finding appears consistent with recent results of wide partisan differences in consumer expectations depending on the party of the President (Curtin, 2022).

For other demographic splits, the differences in inflation perceptions appear more modest. Until recently, inflation perceptions rose and declined about equally for different income groups; in the latest readings, however, perceptions have come down somewhat more for households in the top third of the income distribution than for other households. (Before the pandemic, perceptions of high-income households were also lower than for other households.) Differences by gender, race, and age all appear small.

Figure 5. Median 12-month Inflation Perceptions for Selected Demographic Groups

III. Relationship between inflation / inflation perceptions and consumer sentiment

Consumer sentiment in the MSC has remained persistently lower than pre-covid levels despite strong growth and a tight labor market, prompting researchers to look for explanations (e.g. Herbstman and Brave, 2023, Sahm, 2023). In this section we illustrate the simple contemporaneous correlation between inflation perceptions or actual inflation and consumer sentiment (without attempting to control for other influences on sentiment or the autocorrelation in sentiment). Likely reflecting the relative stability of inflation over the few years prior to the pandemic, there was not strong relationship between inflation perceptions and sentiment (the blue line in the left panel in Figure 6). However, during the recent high inflation period, a strong negative relationship between inflation perceptions and consumer sentiment emerged (red line in the left panel in Figure 6). The right panel in Figure 6 does the same exercise but with actual CPI inflation and gives a similar picture. The strong contemporaneous relationship between inflation/inflation perceptions and sentiment since early 2020 is similar to the relationship observed during the two decades between 1980 and 2000 (red line in Figure 7). This simple relationship suggests that sentiment is likely to improve as perceptions of inflation decline. However, if perceptions are lagging actual inflation on the way down, it might take longer for sentiment to recover.

Figure 6. Relationship between sentiment and inflation/inflation perceptions, 2016-2023

Figure 7. Relationship between sentiment and inflation, 1980-2019

IV. Conclusion

In sum, we find that inflation perceptions rose remarkably closely with actual inflation in 2021 and early 2022. In 2023, however, while inflation perceptions have moved down, they have declined noticeably less than actual inflation. These broad patterns also hold across different demographic groups, though inflation perceptions differ significantly across respondents' political affiliations. Importantly, inflation expectations, particularly longer-term expectations, did not increase as much as inflation perceptions over the pandemic, indicating that households have viewed pandemic inflation as mostly transitory. Even so, given the relationship between perceptions and expectations, inflation perceptions persistently above actual inflation could hold up inflation expectations and affect future actual inflation.

Appendix

Figure A1. Distribution of perceived price changes during the past year

Figure A2. Distribution of the average perceived price changes during the past 5 to 10 years

References

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