This paper explores the formation of households’ wage and inflation expectations in order to better understand the role they play in monetary policymaking and the macroeconomy. It finds that households associate high wage growth with good economic outcomes and high inflation with bad ones, suggesting they see little trade-off between reducing inflation and economic activity.

The findings indicate that people incorporate quite different signals when forming expectations, both over time and for different prices. The authors recommend further work to build on these findings in order to better understand the evolution of expectations, help improve public education and other communication strategies for effective policy.

Findings

• People associate high inflation with worse economic conditions, but higher wages growth with better conditions.
• The relationship between current wage expectations and inflation expectations is relatively weak.
• Estimated monetary policy shocks have a limited effect on expectations despite affecting actual inflation, while oil price shocks tend to move inflation and real wage expectations in different directions.
• Inflation expectations appear to be based more heavily on past conditions, while wage expectations appear to be based more on future conditions.
• Households’ inflation expectations appear to be particularly sensitive to petrol prices, beyond what might be predicted given petrol’s share of households’ consumption.