We see a curious thing happening with inflation expectations today. While consumers are very concerned about inflation over the next 12 months, with average expectations reaching nearly 6%, the Federal Reserve’s calculation, based primarily on financial data, projects just 2.9%. This significant gap reveals an important psychological dynamic at work.
The Psychology Behind Inflation Perceptions
The bias at work here is called availability bias. This bias occurs when people use a rule of thumb to estimate the likelihood of an outcome based on how easily the outcome comes to mind from seeing or hearing information in the media. Easily recalled outcomes are perceived as being more likely than those that are harder to recall or understand.
The conclusion one can draw is that the one-year inflation rate may not be as drastic a concern as consumers think. Survey data for inflation expectations tends to be higher than measures based primarily on hard data (yields, inflation data, and TIPS).
Economic and Investment Implications
The implications of consumers overestimating inflation include both economic and investing factors:
Economic Impact:
- If consumers think inflation is on the rise, they may reduce overall spending
- They may increase their savings rate as a protective measure
- They often prioritize purchasing goods they believe are increasing in price, like durable goods over services
Investment Consequences:
- Consumers may decide against investing in bonds fearing they’ll lose value (even if inflation is under control), thus driving up yields and borrowing costs
- They may avoid borrowing money because they think interest rates are higher than they actually are in real terms
- Overall, overestimating inflation can cause economic distortions that add to volatility in the markets and lead investors to behave irrationally
Finding Balance in an Uncertain Environment
While inflation remains a key concern for consumers, the data suggests that expectations may be running hotter than reality. The gap between consumer sentiment and actual market-based inflation projections reflects how psychological biases, like availability bias, can skew perception. When people are bombarded with headlines about rising prices, they may overestimate the broader economic impact, even when objective indicators show inflation is moderating.
This disconnect matters. When consumers act on inflated fears, by pulling back on spending, misallocating investments, or avoiding credit, they risk creating the very economic imbalances they’re trying to avoid. It’s a reminder that perception can be powerful, but it’s not always accurate. Staying grounded in data, rather than headlines, is essential for making smart financial and policy decisions in a complex economic landscape.
The inflation outlook can be complex. Speak with your Sunpointe advisor to understand how these trends affect your financial plan.
