New research suggests that the recent inflation spike may have permanently scarred Gen Z and made them fear prices rising. This could make central bankers’ jobs more difficult for many years to come.
An analysis of Bank of England statistics found that young people in Britain are more likely to anticipate high inflation continuing after experiencing double-digit growth prices for the first. This is a problem for policymakers trying to achieve a 2% target of inflation by discouraging employees from raising wages.
Michael Saunders (a former Bank of England rate setter and senior advisor at Oxford Economics) said that the British situation has seen a significant increase in inflation expectations amongst young people.
He said that it was reasonable to expect some scarring of inflation expectations. “The young, who believed that high inflation meant 2% or even 3% might now have a wider range of expectations as to where inflation could be.”
The younger generations are historically more conservative in their inflation expectations. They remember the price spikes that occurred during the 1970s and 80s.
Analysis based on UK-based data revealed that the inflation expectations of Generation Z aged 16-24 have increased more than those in any other age category since the pandemic in Ukraine and the war there sent prices soaring.
Other research on the Federal Reserve suggests that inflation’s experience effect can even affect central bankers.
The rising interest rates and pressure on workers to increase their pay are a sign that the situation is likely to continue.
The research is significant because it addresses how people’s expectations of inflation are formed and how a period marked by higher prices can change their thinking.
Inflation expectations are a key factor in determining pay demands and, ultimately, price setting by businesses. Policymakers must control these expectations to ensure they remain at 2%.
The “experience effect” is what economists call it, whereby people who lived through the volatile and high-priced periods in the 1970s or 1980s are more likely to remember them than those who only know about history.
Inflation in the US and Europe had been low for three decades prior to the pandemic. Millennials and Gen X (now aged 27-58) had little impact on inflation during their early years of employment and youth. In the UK, Gen Z is already predicting higher inflation rates than older generations.
According to an analysis of a BOE poll, Britons aged between 16 and 24 experienced the largest increase in their inflation expectations prior to high inflation becoming a major problem for central banks. This age group was least likely to anticipate an increase in prices greater than 3% by August 2020. They are now the second most likely group, behind only those aged 55-64 who grew up during a time of high and volatile prices.
Sanjay Raja is the chief UK economist for Deutsche Bank. He said that younger respondents see inflation as being more range-bound. This may be linked to their childhood, when inflation was relatively low for a long time. The longer inflation is above target, the more inflation expectations are likely to rise across all age groups. Younger generations will be the most affected.
Ulrike Malmendier is a professor of Economics at the University of California, Berkeley. She has conducted research on this effect.
She said that dramatic economic experiences such as high unemployment and inflation spikes have a long-lasting impact on the way you form your beliefs.
Consumer behavior could change dramatically in countries that have experienced the most inflation, like the UK and some parts of the Eurozone.
“This experience effect is more likely to kick-in,” said Malmendier. This can have positive effects, like consumers saving more.
Research suggests that the experience effect could influence central banks and even be passed on to future generations.
Malmendier discovered that the inflation experience of Federal Reserve rate-setters could determine their hawkish and dovish voting leanings. It is possible that the experience of central bankers in the future could be influenced by their post-pandemic surge.
Fabio Braggion is a professor of finance at Tilburg University. He conducted a study that found the scarring caused by inflation could even be passed down to future generations.
He said that households in European countries who experienced hyperinflation prior to 1930 now have inflation expectations that are 1.4 points higher than those of countries that did not. Germany, which suffered hyperinflation in the Weimar Republic, has households with inflation expectations that are 1.4 percentage points higher than those who avoided it.
Braggion stated that this could suggest that inflation expectations may be cultural.
In an interview, he stated that “we suggest two possible channels.” “One of the channels is intergenerational, so that you can talk about it with your family. We then looked at the role played by institutions. “Even today, we can see that local newspapers tend to report more on inflation in areas with higher inflation rates in the 1920s.”
Central bankers may find it harder to do their job if the inflation expectations of younger people catch up with those of older generations.
Many policymakers expect a more volatile environment for inflation after Covid and the Russian Invasion of Ukraine. This follows a period that was unusually benign. The inflation expectations of younger generations, who previously were not affected by price increases, could change.
Saunders added that a world where supply shocks were more frequent would likely cause inflation expectations settle above the target constant rates. This would make it “much harder for central banks to bring inflation back to their target.”