The Phillips curve, a relationship between the unemployment rate and inflation, has come under sharp criticism lately. Contrary to what the Phillips curve would predict, the massive uptick in unemployment during the Great Recession has not resulted in much deflation. Instead, inflation has mostly bounced between 1 and 2 percent over the past several years.
A possible contributing cause has been household expectations of inflation. Although inflation since the beginning of the Great Recession has averaged around 1.5 percent per year, households have consistently predicted inflation to be 3 percent. If the Phillips curve is augmented to include these expectations, then it explains that data very well.
But that just pushes the question one step further – Why have people been consistently overestimating the inflation rate? As we can see in the graph below, this positive bias is a relatively recent phenomenon, as the difference between the forecast and actual inflation tends to bounce around zero for the majority of the period 1978-2014. Only recently (and for a couple of years in the mid-1990s) has inflation forecast been consistently upwardly biased.
A forthcoming paper by Coibon and Gorodnichenko explains this bias by showing that household inflation expectations have tracked oil prices quite closely. They hypothesize that this is due to the undue influence gasoline prices play in the minds of consumers (it is the one price that virtually everyone that drives sees multiple times per day, and nightly news reports obsess over oil prices).
In contrast, Robert Waldmann has a post up today on Angry Bear which asserts that the reason for the higher inflation expectations has been due to the right-wing paranoia over high inflation. He thinks that constant cries on Fox News that inflation has been too high (or will soon explode) has led to the upwardly biased inflation expectations.