Anchoring inflationary expectations

(Mains GS 3 : Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.)

Context:

• Recently, the RBI released the Inflation Expectations Survey of Households (IESH) for March 2022.
• The survey aims at capturing subjective assessments on price movements and inflation of about 6,000 households based on their individual consumption baskets across 19 cities.

General price rise:

• Inflation refers to a general increase in prices of goods and services in an economy and  when the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money.
• The impact of inflation is felt by everyone; therefore, individuals form expectations about how prices will behave in the future to take precautions.
• If individuals anticipate high inflation, they negotiate wages or rents to compensate against a potential fall in their purchasing power.
• Further, increased wages increase the cost of production, making expectations self-fulfilling and, therefore, playing a pivotal role in determining inflation.

Inflation expectations:

• A significant factor shaping perceptions on inflation are the prices that individuals observe in their daily lives.
• A recent study carried out by Acunto et al., 2020, validates that what agents frequently purchase, instead of those purchased infrequently, shape their perception of the general level of inflation. 
• Goods purchased frequently such as groceries tend to be low-priced and highly volatile in comparison to those which are bought seldom. 
• In other words, the prices of the lower-priced potatoes, milk, or apples frequently purchased shape the aggregate inflation expectations more than that of infrequent purchases of a high-priced car.
• Therefore, generalising aggregate inflation expectations for making general views of prices in the economy could be misleading.

Traditional gender roles:

• Existing literature shows that women have higher inflationary expectations compared to men.
• Economic theories explain this divergence by stating that women are 'more pessimistic' than men, attributing the pessimism to the difference in their innate characteristics, lack of education, financial literacy, and preferences.
• However, now studies reveal that it is not the innate characteristics as much as the traditional gender roles that explain this divergence.

‘Natural experiments’:

• Trends of Inflation Expectations Survey of Households (IESH) before and after the lockdown period presents a crude 'natural experiment' to understand the gender-based differences in anticipating inflation.
• Natural experiments are real-life circumstances that can be studied to determine the cause-and-effect relationship among sections of people with different exposure levels to an assumed causal factor. 
• Traditional gender roles are the primary reasons behind the gender inflation expectation gap, thus the lockdown-imposed work-from-home (WFH) arrangements or loss of employment contribute to closing this gap. 
• The gender gap inflation gap is closing because during the lockdown, people in urban areas lost jobs or remained at home, taking a relatively equal share in the frequent day-to-day purchases.

Experience effect:

• In a recent study two categories of occupations were studied i.e. homemakers (assumed to be dominated by women) and financial sector employees (assumed to be dominated by men). 
• Looking at the trends of the RBI surveys for the period between March 2018 and March 2020, homemakers report higher inflation expectations than financial sector employees. 
• However, this gap has narrowed over the last two years and has almost converged in March 2022. 
• A possible explanation of closing the gap could be the gradual 'experience effect' of male-dominated financial sector employees. 
• Experience effect, contrary to Rational Expectations Theory that assumes individuals base their decisions on the information available to them, is based on the premise that actual personal experiences shape behaviour more than being informed about the outcome of the event. 

Conclusion:

• For making better policy decisions concerning macroeconomic phenomena, focus could be shifted more on the understanding of macroeconomic outcomes by studying factors that shape individual behaviour and decision making