Buried at the bottom of August's disappointing Conference Board consumer confidence report is a troubling nugget. Consumers expect inflation of 5.8 percent for the coming 12 months.
That dire projection, which could help explain consumers' sour mood, is much higher than the prediction of the professional forecasters surveyed by the Philadelphia Fed. They see inflation of about 2 percent over the next four quarters. And it's much higher than the Federal Reserve's forecast. As Fed Chairman Ben Bernanke said in his speech last week, "we expect inflation to settle, over coming quarters, at levels at or below the rate of 2 percent, or a bit less."
But this alarmism over inflation on the part of consumers is nothing new, and it may not be warranted. We've given a lot of grief to professional forecasters, who never seem to know when a recession is about to begin or end. But when it comes to projecting inflation, the amateurs don't do very well, either.
The Conference Board sent me a time series of inflation expectations going back several years. And it shows that the public always seems to think inflation is spiraling out of control, even in periods when prices are broadly falling. In July 2010, consumers surveyed by the conference board thought inflation would be 4.9 percent in the next 12 months. But according to BLS, inflation, as measured by the Consumer Price index, rose 3.6 percent in that time period — consumers were off by 50 percent. In July 2009, consumers surveyed by the Conference Board thought inflation would be 5.5 percent in the next 12 months, as the chart below shows. But from July 2009 to July 2010, prices rose just 1.2 percent, according to the CPI. Consumers were off by a factor of four. And consumers never see deflation coming. In July 2008, consumers in the survey thought inflation would rise a whopping 7.5 percent in the next 12 months. Instead, the CPI fell 2.1 percent between July 2008 and July 2009 according to BLS. That's a huge miss, off by 960 basis points.
And so on. For the last four years, consumers in the survey have consistently forecast that inflation would be 5 percent or more in the coming 12 months.
What gives? There are a couple of possibilities. It could be that the nation's primary measure of inflation, the consumer price index, systematically undercounts inflation and has been doing so for decades. There could be an immense conspiracy carried out under the last several presidential administrations aimed at making Americans believe prices aren't really rising much.
Or it could be that there is a disconnect between what people think, feel, and fear about inflation, and the reality of rising prices. It's easy to notice the price of things that are going up — especially gasoline, which people purchase frequently and whose price is loudly and publicly advertised. When prices of goods and services stay the same, or fall a bit, or deliver a higher value for the same price — think of toys, or cars, or computers, or internet access — it frequently doesn't register. People, being human, are prone to emotion. They feel the pain of paying higher prices much more acutely than they notice the pleasure of prices of other things falling or remaining stagnant. And so they tend to accentuate the negative and eliminate the positive when it comes to their assessment of whether life is getting more expensive.
Also, there are a host of individuals and companies who benefit from freaking people out about inflation — i.e. gold bugs, bond vigilantes, politicians who believe that the Fed, simply by printing more money, creates inflation. The media contributes too. When gas pierces $4.00 per gallon, it leads the news. In periods when energy prices fall, few outlets run features on the plummeting price of gasoline.
Regardless, the fear of higher inflation shouldn't simply be ignored or downplayed, especially at a time of weak labor markets and stagnating wages. This perpetual concern helps contribute to a permanent dampening of the mood. If you always think prices are going up significantly and you know that wages haven't been rising at anywhere near that level, you're going to feel down. Fear of a wage-price spiral is rampant — only with no signs of a wage spiral.
Here's the irony. Many experts believe that a higher level of inflation would be helpful given the macroeconomic circumstances — low interest rates, slow growth, high levels of debt. Economists like Harvard's Kenneth Rogoff, co-author of This Time is Different, have called for the Federal Reserve to target "moderate inflation of, say, 4 to 6 percent, for several years." Actual inflation — an interaction of rising prices and rising wages — makes it easier for people and companies to pay down fixed-rate debt. It also encourages businesses and consumers to spend now, rather than later.
Given that people seem to be incorporating higher inflation into their mindsets, perhaps policymakers should consider indulging them.
Daniel Gross is economics editor at Yahoo! Finance
Email him at email@example.com; follow him on Twitter @grossdm