Would Households Understand Average Inflation Targeting?

Abstract

Yes, they would. We collect medium- and longer-term inflation expectations from 9,000 individuals in Germany. Unconditionally, the average probability mass is well-centered around the ECB’s inflation aim of 2%. In a randomized control trial, we subject groups of respondents with information about a hypothetical alternative ECB monetary policy regime akin to the Federal Reserve’s flexible average inflation targeting (AIT). Inflation expectations significantly increase for the treated individuals. When provided with additional assumptions about current inflation, individuals update their expected inflation path in line with the central banks’ intentions. Individuals with a high trust in the ECB’s ability to achieve price stability adjust their inflation expectations particularly strongly. We assess the economic significance of our findings by comparing two model economies under different monetary policy strategies, calibrated to match the difference in medium-term inflation expectations from our survey results. Inflation is six times less volatile and the frequency of hitting the lower bound of interest rates substantially reduced under AIT.