The recent surge in inflation may have left Gen Z permanently scarred and afraid prices will rise, new research shows, in findings that could complicate the job of central bankers for years to come.
Having experienced double-digit price growth for the first time, young people in the UK are more likely to expect high inflation to continue, Bloomberg analysis of Bank of England data found. That spells difficulty for policymakers who are trying to meet a 2% inflation target by discouraging workers from bidding up wages.
“Inflation expectations have gone up a lot among young people,” Michael Saunders, senior adviser at Oxford Economics and a former Bank of England rate-setter, said of the British situation.
“It’s reasonable to expect there will be some scarring on inflation expectations,” he said. “The young who thought that high inflation would mean 2% or 3% now might have a much wider range of expectations of where inflation could be.”
Younger generations have historically had much lower inflation expectations than older age groups that remember the bouts of surging prices in the 1970s and 1980s.
However, analysis based on UK data found that inflation expectations of those aged 16 to 24 in Generation Z have risen more than any other age group since the pandemic and war in Ukraine sent prices rocketing.
Evidence from Europe also indicates that the scarring caused to generations by high inflation can be inherited down the generations, while other research focused on the Federal Reserve in the US suggests that an experience effect from inflation even affects central bankers.
It points to more pressure from workers to raise pay and interest rates staying elevated for longer
The research is important because it touches on how inflation expectations are shaped and how a significant period of higher prices can shift the way people think.
Inflation expectations help determine pay demands, and in turn price setting by companies. Controlling those expectations is a key task for policymakers, who want to keep them anchored around 2%.
Economists call this an “experience effect,” where people living through periods of volatile and high price growth in the 1970s and 1980s have those memories seared more deeply in their thinking than those who just know about it from history books.
For three decades up to the pandemic, inflation across the US and Europe was subdued. It had little bearing on Millennials and Gen X, now aged 27 to 58, during their youth and first years in the workforce. Already, there’s evidence from the UK that suggests Gen Z are expecting higher inflation than those in older brackets.
Analysis of a BOE survey shows that Britons aged 16 to 24 have seen the biggest increase in inflation expectations before high inflation emerged as a major headache for central banks. That age group was the least likely to expect an increase in prices of more than 3% in August 2020. But now they are the second-most likely, just behind those aged 55 to 64 who were growing up and coming of age during a period of high and volatile inflation.
“Younger respondents tend to see inflation as more range bound – linked perhaps closely to the lower for longer era when inflation was pretty subdued for much of their adult lives,” said Sanjay Raja, chief UK economist at Deutsche Bank. “The longer inflation remains above target, the higher inflation expectations will run across all age groups, with younger generations likely to adjust up their expectations the most.”
The experience effect can have a powerful impact, according to research by Ulrike Malmendier, a professor of economics at the University of California in Berkeley.
Dramatic economic experiences, such as high inflation and unemployment spikes “leave a lasting impact on how you form beliefs for years to come,” she said in an interview.
Countries that suffered the worst bouts of inflation, such as the UK and parts of the eurozone, are most at risk of a big shift in consumer behavior.
“This experience effect, this effect that will be ingrained in your thinking for years and decades to come, is much more likely to kick in,” said Malmendier. She said this can lead to some positive impacts, such as consumers saving more.
The experience effect is so powerful that research suggests it could even influence central bankers and be passed down the generations.
Malmendier found that the inflation experiences of Federal Reserve rate-setters in the US could determine their hawkish or dovish leanings and how they would vote. It suggests that future central bankers could be shaped by their experience of the post-pandemic surge.
Meanwhile, a study by Fabio Braggion, professor of finance and financial history at Tilburg University, found that the scarring related to inflation can even be passed on.
Households in European countries that suffered hyperinflation before 1930 have inflation expectations today that are 1.4 percentage points higher than countries that avoided it, he said. In Germany — which was hit by hyperinflation during the Weimar Republic — households in areas with higher local inflation during this period have higher inflation expectations today.
Braggion said that this suggests that there could be “something cultural” about inflation expectations.
“We suggest two possible channels,” he said in an interview. “One is an intergenerational channel, so you may talk about it in the family. Second, we examined the role of institutions. Even today we see that the local press tends to report more about inflation in areas where inflation was higher in the 1920s.”
The inflation expectations of younger generations catching up with older people could make the task of central bankers that little bit harder.
After Covid and the Russian invasion of Ukraine, many policymakers are expecting a more volatile inflation environment following such an unusually benign period. Inflation expectations could readjust, particularly among younger generations who were once unaffected by price growth.
“A world in which supply shocks are more frequently adverse would probably cause inflation expectations to settle above target consistent rates,” Saunders said, adding that would “make life much harder for central bankers looking to get inflation back to target.”
