The Boston Fed’s Unusual Inflation Theory
The Federal Reserve has consistently maintained that keeping inflation expectations steady is crucial for controlling actual inflation. This theory appears straightforward—essentially, if the public doesn’t anticipate soaring inflation, it’s less likely that inflation will rise significantly.
However, a recent study from researchers at the Boston Fed suggests that these expectations may be faltering. According to the report, household inflation expectations have surged to heights not witnessed since the 1970s, leading to concerns about potentially dangerous “unanchoring” that could trigger another inflation spike. Yet, the basis for their caution relies on questionable measurement techniques, contradictory data, and some misleading citations from academic research.
In their paper titled, “Why Have Inflation Expectations Soared Lately? A Historical Perspective,” researchers Philipp Andrade and Michael Wickline propose that we may be experiencing a situation similar to the 1970s. They attribute household inflation expectations to recent significant price shifts, particularly in essential items like food and gas. Anything that doesn’t fit this narrative gets labeled as “unaccountable factors,” which they interpret as a continuous concern that keeps central bankers awake at night.
The results are unsettling. This past spring, expectations jumped an “unexplainable” 7.5 percentage points, echoing patterns from the late 1970s. If households anticipate rising inflation, then, hypothetically, workers might demand higher wages to maintain their purchasing power. Companies, facing increased labor costs, might raise prices, creating a cycle. The authors point out that if workers expect a 4% rise in prices next year, they’re likely to seek raises to keep up.
This makes one stop and think—when was the last time you asked your boss for a raise based on expected inflation increases? How do you think that conversation would go?
If the Fed’s theory hinges on workers acting like economic analysts and bosses following suit by granting raises, then perhaps more evidence is needed than the Boston Fed has provided.
Neil Dutta’s Striking Counterarguments
Neil Dutta, a macroeconomic strategist, has offered a strong rebuttal to the Boston Fed’s position.
First, he notes that corporate expectations seem subdued. According to a survey by the Atlanta Fed, corporate optimism for the year rests at 2.3%, unchanged from last year. Should households truly be bracing for 5% inflation, wouldn’t businesses—who directly influence pricing—take notice? Companies, after all, are more motivated to grasp the inflation outlook since their profits depend on accurate predictions, not just public sentiment.
Second, the anchoring theory collapses when examined with different data sources. Dutta reassessed the Boston Fed’s model using three various consumer surveys, with widely varying results. For instance, the University of Michigan study explained just 47% of expectations variation, leaving a notable “puzzling gap.” Meanwhile, using the Conference Board survey yielded only 29% correlation, and the New York Fed Consumer Expectations Survey nearly matched the predicted values, suggesting that the findings depend heavily on the chosen data.
Third, the mechanism connecting expectations to wage growth appears flawed. Despite high inflation concerns in surveys, actual wage growth has been slowing. Workers can’t simply demand raises based on survey responses; they need negotiation skills, which are losing strength in the current job market. Dutta argues that the link between survey responses and wage pressures is tenuous at best.
Do Inflation Expectations Hold Real Value?
The Boston Fed refers to a 2025 paper by Olivier Coibion and Yuri Gorodnichenko, emphasizing household expectations, suggesting they influence firms’ wage and pricing decisions more than expert predictions do.
However, this paper does not support that claim. Coibion and Gorodnichenko confirm that while household expectations correlate closely with inflation, the causal relationship diverges. They found that firms tend to meet their own expectations when setting prices rather than those of households. Moreover, minimal transition from inflation expectations to wage expectations was documented: a 1% rise in inflation expectations leads to only a 0.1% rise in anticipated nominal income.
In simpler terms, a boss doesn’t hand out raises simply because inflation forecasts are rising.
Additionally, while inflation has surged, people’s expectations regarding their wages remain pretty stable. There’s little evidence of a wage-price spiral, particularly one stemming from unfounded expectations from households.
In fact, Coibion and Gorodnichenko present a clearer model: inflation expectations primarily influence inflation through firms’ pricing strategies, not wages. Companies with fixed prices tend to raise their prices when they anticipate that profit margins might shrink due to inflation. So, the key indicator isn’t how consumers perceive inflation; it’s how businesses are planning ahead.
And as Dutta emphasizes, by that measure, expectations seem to remain well anchored.
The Boston Fed closes with a grim forecast, indicating rising inflation expectations among households and businesses, warning that we might be on the verge of a second inflation surge.
This seems far-fetched. Business expectations appear steady. Alternative research indicates that household expectations mirror recent prices without predicting future trends. Wage growth is decelerating as employment lessens. While households might expect further inflation, placing too much hope on that front probably won’t lead to a sharp rise in prices.
And let’s not forget—Jerome Powell, with several months ahead of him, appears primarily concerned about interest rates being too high during Democratic leadership while Joe Biden, often criticized for sparking the last inflation surge, seems to be off “busy eating ice cream” somewhere in Delaware.
