February 20, 2025, Filed Under: Blog EntryWhat would you pay to eliminate business cycles or inflation? By Dimitris Georgarakos, Kwang Hwan Kim, Olivier Coibion, Myungkyu Shim, Myunghwan Andrew Lee, Yuriy Gorodnichenko, Geoff Kenny, Seowoo Han, and Michael Weber Imagine a world where macroeconomic ups and downs don’t disrupt our lives. No recessions that put your job at greater risk, no skyrocketing prices, no financial crises, etc. Sounds ideal, right? But how much would you be willing to sacrifice to make that a reality? To answer that question, we surveyed consumers across thirteen advanced economies to see how much individuals would trade in terms of their lifetime consumption to eliminate economic volatility (Georgarakos et al. 2025). Here’s what we found. Key Findings: People are willing to give up 5-6% of their lifetime consumption to eliminate economic ups and downs. They are also willing to sacrifice around 5% of their lifetime consumption to achieve their preferred inflation levels. These figures are much higher than what traditional economic theories suggest. In other words, while past research has suggested that stabilizing the economy wouldn’t make a big difference in terms of welfare, our study finds that real people think otherwise. Why Do People Care So Much about Business Cycles? We found that several factors are particularly important in determining how much people would be willing to pay to avoid business cycles, as illustrated in Figure 1 below. Personal Experience with Macroeconomic Volatility People in countries with historically volatile economies are willing to pay more. In our sample, Germany and the Netherlands are the two countries with the lowest macroeconomic volatility over the last thirty years, and consumers in those countries report that they would sacrifice around 3-4% of their consumption to eliminate business cycles. In the two most volatile countries in our sample, Spain and Greece, consumers would be prepared to sacrifice almost twice as much to eliminate business cycle risk. Cyclicality of Consumption and Income Individuals whose spending and income are more sensitive to changes in the state of the economy feel the effects of downturns more. As a result, we would expect them to be willing to sacrifice more to avoid instability. We find that this is indeed the case. Because of the different types of jobs and assets that people have, there is remarkable variation in the extent to which people are caused, either positively or negatively to business cycle fluctuations. The U.S., for example, is one of the countries in which people’s incomes are the most sensitive to business cycles, and U.S. consumers correspondingly report some of the highest WTP to achieve economic stability across countries. Economic Uncertainty Our willingness to pay to eliminate future business cycles should also depend on how big we think those future cycles are likely to be: those who foresee very little economic volatility in the future should not be willing to pay nearly as much as those who expect to see large swings. We find this to be one of the main determinants of people’s WTP to eliminate business cycles, as shown in the figure below. Figure 1: Determinants of the Willingness to Pay to Eliminate Business Cycles There are many other factors that matter as well, but quantitatively, we found these three explanations to be some of the most important when it comes to eliminating business cycles. What about inflation? For inflation, we wanted to know how much people would be willing to sacrifice to see inflation reach the ideal level for them. What inflation rate would that be? We found that people wanted to see prices fall overall, and by pretty large amounts. Part of this desire for falling prices was to offset the perceived price increases during the inflation surge: people living in countries where prices went up more following Covid generally wanted to see bigger price declines than those in countries who experienced more moderate inflation. But just because someone would like to see prices fall doesn’t mean that they would be prepared to sacrifice much to achieve that outcome. So we asked survey participants how much they would be prepared to sacrifice to achieve their preferred inflation target. The answer was again close to 5% of their consumption, on average. Why so high? One reason is that people want to see large changes in the inflation rate. As shown in the figure below, people living in countries where inflation has been low are willing to pay less to reduce inflation, because they perceive a smaller decline as being necessary. Figure 2: Historical Inflation and the Willingness to Pay to Reduce Inflation Another factor that helps explain a high WTP to reduce inflation is the fact that people associate higher inflation with more volatile inflation, and the volatility in inflation is itself perceived as costly as shown in Figure 2. Finally, a third important reason why people are willing to pay so much to reduce inflation is that they seem to perceive higher inflation as happening when economic times are bad, so reducing inflation also serves to reduce business cycle volatility and vice-versa. Consistent with notion, we find that people who report that they are willing to pay more to eliminate business cycles are also willing to pay more to reduce inflation, as shown in Figure 3. Even though macroeconomists view the long-run level of inflation and economic volatility as largely separate things, this is not how consumers perceive them, leading to a strong correlation between their willingness to pay for either. Figure 3: WTP to Eliminate Business Cycles vs WTP to Reduce Inflation Implications for Policymakers Traditional economic models often assume that people don’t worry much about business cycle volatility because they can “smooth” their consumption over time—saving in good times and spending in bad times. But our study challenges that idea. Instead, it shows that people strongly prefer a stable economy and are willing to give up a significant portion of their potential income to achieve it. This insight suggests that macroeconomic policies should align more closely with what people actually value, not just what economic models predict. At the end of the day, economic stability isn’t just an abstract concept—it’s something that affects real lives. Whether it’s job security, price stability, or financial peace of mind, people are willing to pay a surprising amount to avoid uncertainty. For policymakers, that’s a message worth listening to. References: Georgarakos, Dimitris, Kwang Hwang Kim, Olivier Coibion, Myungkyu Kim, Myunghwang Lee, Yuriy Gorodnichenko, Geoff Kenny, Seowoo Han, and Michael Weber, 2025. “How Costly Are Business Cycle Volatility and Inflation? A Vox Populi Approach,” Manuscript.
January 14, 2025, Filed Under: Blog EntryHow Firms Adapt Supply Chains to Climate Risk By Nitya Pandalai-Nayar, Juanma Castro-Vincenzi, Gaurav Khanna, and Nicolas Morales The views expressed are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Richmond and the Board of Governors. As climate change intensifies, extreme weather events and unpredictable climate patterns pose growing threats to economies worldwide. The ongoing unseasonal fires in densely populated, economically important areas of Los Angeles highlight the risks faced to firms and workers from their location choices, given the growing prevalence of such climate shocks.[1] These risks are particularly acute for supply chains, where disruptions can ripple through entire industries, stalling production and raising costs. From floods to droughts and fires, localized climate shocks threaten to destabilize the links between firms and their suppliers. How do firms adapt to these challenges? And what are the broader economic implications of their responses? These questions lie at the heart of Castro-Vincenzi, Khanna, Morales and Pandalai-Nayar (2024). Our paper focuses on India, a country that is highly exposed to climate risks and where regional disparities in climate vulnerability create a natural laboratory for studying firm behavior. By analyzing rich firm-to-firm transaction data alongside regional climate risk indicators, we uncover how businesses adapt their sourcing strategies to mitigate climate risks—and the trade-offs these adaptations entail. The Challenge: Localized Risks in a Globalized World Modern supply chains are highly interconnected and efficient, but they are also vulnerable to disruptions. A localized climate shock in one region—such as flooding or a severe drought—can have far-reaching consequences, especially if firms rely heavily on suppliers in the affected area. For firms, the stakes are high: a disrupted supply chain can lead to production delays, missed deadlines, and significant financial losses. For policymakers, the problem is equally pressing. Climate-induced supply chain disruptions can destabilize local economies, depress wages, and widen regional inequalities. Understanding how firms adapt to these risks is essential for designing policies that foster resilience without exacerbating existing disparities. Tackling the Problem: Data and Methods To explore how firms respond to climate risk, we leverage a detailed dataset of firm-to-firm transactions from an Indian state. This dataset provides granular information on sourcing relationships—which suppliers each firm works with and where those suppliers are located. These data are paired with regional climate risk measures, such as the frequency and severity of extreme weather events. Importantly, we develop a general equilibrium spatial model to simulate how firms make decisions about their supplier networks. The model accounts for key trade-offs: Risk Diversification: Firms can mitigate climate risks by diversifying their supplier base geographically, reducing reliance on any single region. Cost Trade-offs: Diversification often comes with higher costs, as sourcing from additional suppliers or more distant regions can increase logistical and operational expenses. Supplier Behavior: Suppliers in high-risk areas may lower their prices to compensate for the perceived risks, introducing further complexity to firms’ decision-making. Our model is calibrated using data from 271 regions in India, capturing the interplay between climate risks, supply chain dynamics, and regional economic outcomes. Key Empirical Findings: How Firms Adapt Our analysis reveals clear patterns in how firms respond to climate risks. First, we argue that there is Supply Chain Diversification. Firms in regions exposed to high climate risk are more likely to diversify their supply chains, sourcing identical inputs from multiple suppliers spread across different areas. This strategy ensures that a disruption in one region does not halt production entirely. Second, there are Price Adjustments by Suppliers. Suppliers located in climate-vulnerable areas often reduce their prices to retain buyers. These discounts act as a compensatory mechanism, encouraging firms to continue sourcing from high-risk regions despite the associated vulnerabilities. Third, we highlight the Trade-offs in Wages and Costs. While diversification reduces the likelihood of supply chain disruptions, it also raises input costs for firms. Higher input costs, in turn, can suppress wage growth in supplier regions. Suppliers in high-risk areas often face lower wages, reflecting the economic consequences of climate vulnerability. Fourth, we describe the Impact of Floods on Supply Chains. Event study analyses reveal that when suppliers are hit by floods, suppliers see a temporary fall in sales, and downstream buyers see a reduction in purchases. Yet, firms quickly adjust and recover, demonstrating the importance of preemptive resilience strategies. Figure 1 illustrates the short-term sourcing shifts observed after a flood event, showing changes in supplier relationships over time. Figure 1: Effects of floods on sales and downstream purchases. Implications: Resilience and Inequality Our findings have significant implications for firms, workers, and policymakers. First, when thinking about economic resilience, our results argue that supply chain diversification reduces the risk of large-scale disruptions, contributing to overall economic stability. By spreading risk across multiple regions, firms can better withstand localized shocks. On the other hand, this leads to regional disparities. That is, this adaptation strategy can deepen regional inequalities. Areas prone to frequent climate shocks face declining wages and reduced investment, while more resilient regions maintain or even improve their economic standing. In the next 25 years, climate related disasters are expected to increase for some regions while dampen for others. In our project, we use the predicted change in flooding, rainfall, and heat levels by year 2050 to understand how different Indian regions will be affected as well as quantifying how much supply chains can amplify these effects. In panel a of Figure 2, we see that that the Gangetic Plain, the North East, and parts of Gujarat and Tamil Nadu, are expected to face more disruptions while parts of Andhra Pradesh are expected to have relatively lower climate risk. The increase in climate risk will have consequences on welfare (measured by real wages) across regions. Welfare on average decreases by 2.01%. There is wide spatial variation, with a range of 3.11pp, and some of the less risky regions see welfare gains. Supply chains contribute to amplify gains and losses created by climate change. Regions getting riskier will get the direct effect of climate change and are expected to face lower demand for their inputs, as demand moves to safer regions. Figure 2: Expected changes in climate risk and their welfare consequences. Together, these raise policy challenges. Policymakers must address the trade-offs inherent in these dynamics. For example, incentives to bolster infrastructure in high-risk areas could help reduce supplier vulnerabilities, while targeted wage subsidies might alleviate the economic burden on workers in these regions. Our findings underscore the need for proactive interventions to enhance supply chain resilience while minimizing negative economic consequences. Governments and firms can invest in infrastructure and technologies that reduce the vulnerability of suppliers in high-risk regions, such as flood-resistant facilities or advanced logistics systems. Furthermore, policy measures, such as tax incentives or subsidies for supply chain diversification, could help firms manage the higher costs associated with resilience strategies. Finally, policy makers must address wage inequalities, by targeting policies to support workers in climate-vulnerable regions. Such skill development programs, or income support could mitigate the adverse wage effects identified in our study. Conclusion As climate risks such as the Los Angeles wildfires grow, firms are increasingly compelled to rethink their supply chain strategies. Our paper provides a detailed view of how businesses navigate these challenges, offering valuable insights for policymakers and industry leaders alike. While supply chain diversification enhances resilience, it also underscores the uneven economic consequences of climate adaptation. Bibliography Castro-Vincenzi, Juanma, Khanna, Gaurav, Morales, Nicolas and Nitya Pandalai-Nayar, 2024. “Weathering the Storm: Supply Chains and Climate Risk,” NBER working paper No. 32218, March. [1] Estimates of the losses from property damage due to these fires is upwards of $200 billion.
November 13, 2024, Filed Under: Blog EntryWhat does the Trump win mean for the U.S. and global economic outlook? By Olivier Coibion and Nitya Pandalai-Nayar After a long campaign, we have a clear outcome to the election: a Trump victory combined with a likely Republican majority in both houses of Congress. How should we expect this outcome to affect the economic outlook for the U.S. and the rest of the world? Yogi Bera once said “it’s hard to make forecasts, especially about the future.” But given the number of policy changes promised by candidate Trump and that President Trump will soon be free to implement, we view this as an opportune time to reflect on the main forces that we expect to see at work in coming months and years. We first consider the implications of what we view as the three most likely policy changes from a macroeconomic point of view: an increase in tariffs, a mass deportation of illegal immigrants and tax cuts. We then turn to what we view as three major wildcards: Trump’s interactions with the Federal Reserve, the implications of higher economic uncertainty, and the outlook for energy and commodity markets. Together, the likely effect of this combination of policies is to leave the U.S. economy poorer than it otherwise would have been and facing higher prices. Tariff policy: “The most beautiful word in the dictionary,” according to candidate Trump, is tariffs. One promise he has repeated throughout the campaign is to impose large tariffs on Chinese goods and has suggested imposing across-the-board tariffs on all imports. Given the Republican control of Congress and lukewarm historical support of Democrats for free trade, the widespread adoption of higher tariffs by the U.S. is a very likely policy outcome in the near future. Tariffs are a tax on imports. As such, American consumers would face higher prices on Chinese products and those of other trading partners on whom we place such tariffs. The first and most direct effect from such a policy would therefore be to place upward pressure on prices. Imports are around 15% of GDP, so a back of the envelope calculation would suggest that this upward pressure is likely to be minor. This line of reasoning is problematic though because (a) indirect exposure to imports in domestic supply chains is likely to lead to larger across-the-board increases in prices, even in goods produced domestically, and (b) lower income households consume a larger share of cheap imported goods in their daily lives than richer households, so the tariff-led price increases will affect lower income consumers disproportionately. What about possible benefits for the domestic economy? While these higher prices could lead consumers to purchase more U.S. products or induce some production to move back to the U.S., there are several reasons to be skeptical that this would increase U.S. employment much. First, we should expect our trading partners to reciprocate with their own tariffs, much as in the trade wars of the 1930s, so U.S. exporters will face lower demand for their products, reducing U.S. employment. Second, given that the U.S. is already near full-employment and inflation close to the Fed’s target, the Federal Reserve would likely respond to a tariff increase by raising interest rates to offset inflationary pressures, which would reduce aggregate employment. Third, higher tariffs would disrupt global supply chains for U.S. producers, which would likely also place further downward pressure on employment. Hence, the most likely longer-run outcome is unchanged aggregate employment but significantly higher prices overall. Furthermore, we are likely to see inflationary pressures appear even before tariffs are put in place. Consumers and firms will respond to the expectation of higher tariffs in the future by stocking up on Chinese and other international products, before tariffs kick in, which will place immediate upward pressure on those prices (as quantities cannot adjust immediately and short-run supply is predetermined). This will raise the profits of foreign producers at the expense of U.S. consumers. U.S. firms that use these products as inputs will also likely start raising prices in anticipation of the higher costs they will face in the near future. The unanticipated pre-emptive demand for foreign goods could affect shipping costs and product availability, and potentially cause disruptions in global supply chains similar to those that we saw at the onset of the pandemic. At worst, this would tend to raise prices for all products that use internationally-produced inputs, not just those coming from countries that we might target with new tariffs. Hence, the very anticipation of future tariffs in a full-employment economy is likely to lead to immediate inflationary pressures even before the Trump administration comes into office. Mass deportation: The second policy that candidate Trump has promised is “the largest domestic deportation operation” of illegal immigrants. How widespread such a deportation might be, or how rapid, remains unclear but the current expectation given the language used in the campaign is that it is likely to be large-scale. What would an immediate deportation of millions of people from the U.S. imply for the economy? First, the expulsion of immigrants would correspond to a reduction in the supply of workers to the U.S. economy, targeted toward specific industries like construction, agriculture and services: what macroeconomists would typically refer to as a “stagflationary” shock. The “inflationary” part comes from the fact that such a policy would raise the cost of production in these sectors and would therefore tend to exert inflationary pressure on houses, food products, and the service sector. The “stagnation” part comes from the fact that with fewer workers, our economy will produce less. Whether the decline is large enough to induce a recession will depend on how large the deportation turns out to be. Second, immigrants are a source of demand for the U.S. economy, since they purchase products and services made in the U.S. A large-scale deportation would therefore tend to reduce aggregate demand, which would put downward pressure on employment of U.S. workers but also downward pressure on domestic prices. Together, the net effect of a deportation is therefore to primarily reduce total employment in the U.S., both from immigrants and non-immigrants, leading to a sharp decline in overall economic activity. Whether prices overall end up rising or falling from this policy change will depend on which channel is most powerful, the decline in labor supply or the reduction in aggregate demand. Tax reform: The third policy reform that we can confidently expect from the new Trump administration is extending the sunsetting tax cuts from the previous Trump administration, perhaps with the addition of new tax cuts. Candidate Trump has proposed eliminating income taxes on tips and on Social Security benefits, for example. Tax cuts tend to be expansionary through the fact that they increase after-tax income, thereby raising employment, production and prices in the economy. The extent to which they do so depends to a large extent on the response of the Federal Reserve. Since the U.S. economy is close to full employment and inflation near the Fed’s target, an expansionary tax cut would likely be offset by higher interest rates on the part of the Federal Reserve, since Fed officials would push back against any inflationary pressure induced by a stronger labor market. We would therefore expect limited effects on both prices and employment from this tax policy. The main consequence would instead be to reduce the revenues of the Federal government. Since there have been few concrete proposals for reducing government spending by candidate Trump to offset the promised tax cuts, the lower revenues will lead to a higher budget deficit and rising U.S. government debt, continuing recent trends from the Biden and prior Trump administration. To the extent that larger deficits exert upward pressure on interest rates, we expect this policy to push interest rates even higher than they would have been otherwise. Summary: The net effect of these policies is therefore a combination of higher prices (coming largely from the tariff policy and tax cuts), lower employment and income (primarily from the deportation policy), higher deficits and debt (due to the tax cuts) and higher interest rates (from the Federal Reserve’s likely response to these policy actions). However, there are a few additional possible outcomes that could affect these predictions, although these are more “wildcards” and we are less confident in how they will play out. Pressure on the Federal Reserve: One of the many ways in which the first Trump administration was unusual is in the public pressure that Trump applied to the Federal Reserve to reduce interest rates. Since the Fed is likely to again be raising rates to offset future Trump tax cuts and tariffs, the stage is set for another confrontation between the two. If the future administration uses Congress to change how the Federal Reserve operates or a Trump administration appoints individuals that follow Trump guidelines for monetary policy rather than those of traditional central bankers, we are likely to see the Fed lower interest rates relative to what we are predicting. This type of accommodation by the Federal Reserve of Trump policies could significantly raise inflationary pressures but offset some of the predicted declines in employment and income. In the longer run, limits to or even the abandonment of the Federal Reserve’s independence would lead to permanently higher and more volatile inflation, which would ultimately reduce the productive capacity of the U.S. economy and the real income of its workers. Because the credibility of the Federal Reserve has taken decades to build, we view the possibility of this as one of the biggest long-term risks to the U.S. economy. Energy and commodity prices: Inflation in the U.S. and the world fluctuates with the prices of global commodities like oil, wheat, copper, etc. To the extent that these prices are determined on global markets, the policies of the U.S. government tend to have only limited effects on them, despite what is proclaimed by political candidates during elections. Candidate Trump has promised to loosen regulations on oil production in the U.S., which would tend to reduce energy prices in the long-run, but also reduce support for alternative energies like solar, which would tend to raise energy prices. So the net direct effect of these policies on overall energy prices -and therefore U.S. inflation- is likely to be muted. What is likely to be more important for commodity prices are developments in the Middle East as well as in the Ukraine-Russia conflict. Predicting how a new administration might affect the risk of further conflagration of conflict in these regions is outside our expertise, but we can expect these to have significant effects on global commodity prices and inflation. Uncertainty: The widespread implementation of new policies, combined with the ambiguity about their likely size and effect, will tend to raise uncertainty about the macroeconomic outlook, for demand, trade, inflation, exchange rates and interest rates. Higher macroeconomic uncertainty tends to reduce investment and hiring by firms, and makes households increase their savings for precautionary reasons, thereby reducing the demand for firms’ products. The overall effect of higher uncertainty on the economy is therefore quite contractionary. Given this, we expect the higher macro-uncertainty from these policy changes, as well as from Trump’s deliberate creation of uncertainty to increase his scope for negotiations, to exert further downward pressure on economic activity. Conclusion: Overall, our expectation is that the new Trump administration will bring with it new inflationary pressures, higher deficits and interest rates, and declines in employment and income relative to what would have happened otherwise. How severe these effects turn out to be will depend on the actual policies that are implemented (e.g. how big are the tariffs, how widespread are the deportations) and the responses of other organizations (the Federal Reserve, our trading partners, etc.). There is scope to hope for better outcomes, for example, if peace in the Middle East and Ukraine were to lead to significant declines in commodity prices. But hope is not a strategy and the potential downside risks loom large. From the possibility of the first global trade wars since the 1930s or incursions on the Federal Reserve’s independence, we could see long-lasting damage imposed on the U.S. and global economy in a very short period of time.
September 25, 2024, Filed Under: Blog EntryLifetime Memories of Inflation: How Our Memories about the Past Shape our Views about the Future By Isabelle Salle, Olivier Coibion and Yuriy Gorodnichenko Summary – The post-pandemic surge saw an entire generation live through its first episode of significant and persistent inflation. In this blog, the authors investigate how people’s memories of past inflation affect their beliefs about future inflation, using a survey and a lab experiment. They find that memories of past inflation can have long-lived effects on individuals’ inflation expectations. Since these expectations shape the tradeoff that policymakers face in trying to stabilize economic conditions, this suggests that the consequences of the recent inflation on policy-making may continue to be felt long after inflation has been tamed. With inflation recently breaching 10% in many advanced economies for the first time in decades, an entire generation has lived through its first bout of significant and sustained price. How will this experience shape their beliefs in the future? Earlier evidence, surveyed in Malmendier and Wachter (2023), has shown that cataclysmic macroeconomic events can significantly shape the beliefs and economic decisions of a generation, from those Americans going through the Great Depression (Malmendier and Nagel 2016) to Germans who lived through the 1920s hyperinflation (Braggion et al. 2023). The recent inflation spike, however, is of an order of magnitude smaller than these catastrophes. Will its effects therefore rapidly fade, or will it be sufficient to have scarring effects on how people perceive inflation and monetary policy in the future? This is a pivotal question for central banks, considering the imperative to maintain inflation expectations of the public well anchored to their low inflation targets to forestall the entrenchment of higher inflation. Our recent research (Salle et al. 2023) seeks to answer this question by using both a large-scale household survey of the Dutch population and a laboratory setting with students at the University of Amsterdam during the recent inflation peak in the Netherlands. Our results suggest that the recent rise of inflation may have long-lived effects on people’s inflation expectations, potentially complicating the central banks’ efforts to stabilize inflation for years ahead. Individual memories are more diverse than common historical experiences We first asked the lab participants and the survey respondents to describe up to two episodes of rising and decreasing inflation over their lifetime. They were invited to specify the time and location, recall the lowest and highest inflation rates, note the amplitude of the changes, rate their confidence in their memory, identify the perceived cause, and describe the impact on their personal finances. We find that individual memories differ greatly across individuals, even when they belong to the same generation. Panel A of Figure 1 plots the distribution over time of inflation surges and disinflations cited by survey respondents. Overall, participants are more likely to recall rising rather than decreasing inflation, with a large spike around 2021 and 2022, where around forty percent of survey participants recall an inflation surge. A second spike in both inflation and disinflation memories occurs around 2008-2010, when substantial changes in food and commodity prices occurred in the wake of the Great Financial Crisis. A smaller spike in recollections happens around 1980, when inflation in the Netherlands was high and volatile, leading households to recall both the inflation surge and the subsequent disinflation. Another example of this variation is the reported causes of these changes in inflation (see, respectively, Panels B and C of Figure 1). Episodes in the 1970s and from the 2010s were more likely to be attributed to input and energy cost changes than during the 80s-00s. Disinflation in the 1990s is attributed by many to currency changes, consistent with the large appreciation of the Dutch guilder around this time. For the 1980s, many do not remember the reason for the disinflation but about thirty-five percent of those who do attribute the disinflation to policy or lower demand for goods, with another fifteen percent emphasizing energy and input price changes. We also find a salient asymmetry when it comes to the effect of these episodes on household finance: while most respondents report that inflation surges made them worse off, there is little agreement about whether disinflations made them better off. This range of recalled memories clearly indicates that individual experiences cannot be reduced to the past economic events that they have lived through together. How do these personal memories affect people’s beliefs and attitude towards inflation beyond their common historical experience? Individual memories affect beliefs beyond common historical experiences After their inflation memories, we elicited the respondents’ views about inflation up to 2025 along with a range of other personal opinions and preferences. We employed econometric techniques to link detailed lifetime memories with inflation outlooks and particularly policy-relevant beliefs, including trust in the central bank and awareness of its primary goal. Our comprehensive questionnaire controls for numerous potential confounders, and we incorporate historical inflation data to separate the influence of personal memories from collective experience. Figure 1: Lifetime Memories of Inflation and Disinflation Episodes Notes: Panel A shows the distribution of recalled inflation/disinflation episodes by year, Panels B and C breaks it down by decade and main reason reported. We find that inflation and disinflation memories are correlated with inflation forecasts. Recalling past inflationary episodes is associated with a higher inflation outlook and more confidence in these outlooks. By contrast, the larger are the disinflations recalled, the lower are the inflation expectations. Interestingly, the largest effect on expectations is observed for disinflations that people attribute to policy. Recalling past disinflations is also associated with more uncertainty regarding future inflation, reflecting the fact that these people envision a broader set of possible future inflation outcomes. Additionally, we report clear evidence that inflation memories are closely tied to trust in the ECB. Recalling past increases in inflation is associated with less trust while recalling disinflationary episodes with more trust. We also find that memories of both inflation surges and disinflations are associated with a deeper knowledge about instruments and objectives of monetary policy. An important policy-relevant take-away from this analysis is that those who remember prior disinflations are more open to the possibility of future inflation declining sharply, such that they have lower inflation forecasts on average, consistent with more trust that the ECB will be successful in bringing inflation back to its target. Is it merely an association or do various inflation memories cause different inflation expectations? If so, can we artificially recreate lifetime memories of inflation that can also shift people’s expectations? Creating pseudo-life experiences through games treatments After eliciting their inflation expectations, some survey and lab participants were randomly chosen to play a game that consisted in repeatedly predicting next year’s inflation while incrementally observing inflation in the previous years. These “treated” individuals played either with data from a rising inflation episode (over 1967-1975), a decreasing inflation episode (over 1980-1988) or a flat inflation episode (over 2006-2014), while the rest of the respondents skipped the game as they constitute the “control” group. We then elicited once more inflation expectations to explore how the game treatments may have affected these expectations, while accounting for their inflation priors and retrieved memories. We find that playing the forecasting games can have powerful effects on expectations, both in the lab and in the survey, and these effects largely mirror those of inflation memories: playing through a period of rising inflation raises inflation expectations, whereas playing through an episode of flat or falling inflation tends to reduce inflation expectations. This latter treatment effect is larger for respondents who did not report any inflation memory or who declared relatively higher prior beliefs about inflation. Interestingly, in a follow-up survey conducted months later, individuals were more likely to recall both inflation surges and disinflations if they had played a game with decreasing inflation in the first wave, with the effect of disinflations being particularly strong for young survey participants. Furthermore, consistent with the idea that forecasting games create new memories, we find that the effects of the game experience on inflation expectations persist in the follow-up survey, even after accounting for individuals’ prior memories. Conclusion Our results suggest that inflation memories at least partly cause inflation expectations. Therefore, the recent inflation surge could persistently affect household inflation expectations. How it does so, however, will depend on whether individuals’ memories focus more on the inflation increase or the ongoing disinflation, as the two affect expectations quite differently. Policy communication could play a role in shaping the future narrative that individuals will recall about the current inflation dynamics. Delving further into how memories are formed and persist would allow for a better understanding of how a specific episode like the recent inflation surge is likely to affect economic expectations and the conduct of monetary policy in subsequent years. Graeber, Roth and Zimmermann (2023) provide novel evidence on the formation of memories, for example. Our work also helps bridge the gap between the survey and the lab experimental literature: while lab subjects are young college students and do not share the much longer life experiences of the broader population, our results suggest that game experience can partially recreate that life experience and help make them more representative of the broader population. Because laboratory experiments have many advantages in other respects, the ability to make their participants more diverse could help expand the scope of questions that can be fruitfully addressed in the lab. Bibliography Braggion, Fabio, Felix von Meyerinck, Nic Schaub, and Michael Weber, 2023. “The Long-term Effects of Inflation on Inflation Expectations.” Manuscript. Braggion, Fabio, Felix von Meyerinck, Nic Schaub, and Michael Weber, 2023. “The Long-term Effects of Inflation on Inflation Expectations.” VoxEU https://cepr.org/voxeu/columns/long-term-effects-inflation-inflation-expectations. Graeber, Thomas, Christopher Roth, and Florian Zimmermann, 2023. “Stories, Statistics and Memory. VoxEU https://cepr.org/voxeu/columns/stories-statistics-and-memory. Kose, M. Ayhan, Franziska Ohnsorge, and Jongrim Ha, 2022. “Today’s inflation and the Great Inflation of the 1970s: Similarities and Differences,” VoxEU https://cepr.org/voxeu/columns/todays-inflation-and-great-inflation-1970s-similarities-and-differences. Malmendier, Ulrike, 2008. “’Depression Babies’: do macroeconomic experiences affect risk-taking,” VoxEU Talk interview with Vaitilingam. https://cepr.org/multimedia/depression-babies-do-macroeconomic-experiences-affect-risk-taking Malmendier, Ulrike, and Stefan Nagel, 2016. “Learning from Inflation Experiences,” Quarterly Journal of Economics 131(1): 53-87. Malmendier, Ulrike and Jessica A. Wachter, 2023. “Memory of Past Experiences and Economic Decisions,” In M. Kahana and A. Wagners (eds), Handbook of Human Memory, Oxford University Press, forthcoming. Salle, Isabelle, Yuriy Goronidchenko and Olivier Coibion, 2023. “Lifetime Memories of Inflation: Evidence from Surveys and the Lab,” NBER working paper No. 31996, December. Wohlfart, Johannes, Ingar Haaland, Christopher Roth and Peter Andre, 2023. “Inflation narratives,” VoxEU https://cepr.org/voxeu/columns/inflation-narratives.
