Downside Inflation Risk

Earlier this month, New York Federal Reserve President William Dudley gave a speech on "The U.S. Economic Outlook and Implications for Monetary Policy." Like other Fed officials, Dudley expressed concern about falling inflation expectations:

With respect to the risks to the inflation outlook, the most concerning is the possibility that inflation expectations become unanchored to the downside. This would be problematic were it to occur because inflation expectations are an important driver of actual inflation. If inflation expectations become unanchored to the downside, it would become much more difficult to push inflation back up to the central bank’s objective.

Dudley, perhaps because of his New York Fed affiliation, pointed to the New York Fed’s Survey of Consumer Expectations as his preferred indicator of inflation expectations. He noted that on this survey, "The median of 3-year inflation expectations has declined over the past year, falling by 22 basis points to 2.8 percent. While the magnitude of this decline is small, I think it is noteworthy because the current reading is below where we have been during the survey history."

The 22 basis-points decline in 3-year inflation expectations that Dudley referred to is the median for all consumers. If you look at the table below, the decline is more than twice as large for consumers with income above $50,000 per year.

Source: Data from Survey of Consumer Expectations, © 2013-2015 Federal Reserve Bank of New York (FRBNY). Calculations by Carola Binder.

This might be important since high-income consumers' expectations appear to be a stronger driver of actual inflation dynamics than the median consumer's expectations, probably because they are a better proxy for price-setters' expectations. These higher-income consumers' inflation expectations were at or above 3% from the start of the survey in 2013 through mid-2014, and are now at their lowest recorded level. Lower-income consumers' expectations have risen slightly from a low of 2.72% in September 2015. We need a few more months of data to separate trend from noise, but if anything this should strengthen Dudley's concern about downside risks to inflation.