Election results are not a factor. This is usually a combination of economic, political, and social factors, but the rising cost of living appears to be a key factor in America’s performance.
President Trump’s victory was sealed by the end of Conservative rule in the UK and the collapse of the ruling political alliance in Germany.
There are also some lessons for economists. Most importantly, voters will start thinking not only about the rate of change in prices, but also about the price level. In many rich countries, the price of a cup of coffee or a bag of groceries has changed dramatically over the past four years.
Even tourists can feel it. Therefore, inflation, or the rate of increase in prices, may have been affected. However, previous spikes in inflation pushed price levels well above what voters were comfortable with.
The lingering effects of past inflation on current voting behavior, and perhaps economic behavior such as wage demands and profit calculations, mean that we should not base our choices solely on what lies in the future, but rather on the shadow of the past. It also means that a selection is made.
In more technical terms, inflation expectations can become adaptive rather than rational, especially if policy credibility is shaken. Therefore, when formulating macro policy in response to an unexpected burst of high inflation, macro policy needs to be more conservative than usual.
Related to all this is the idea of rational indifference to inflation. Research shows that the public often has no idea about the trajectory of inflation in normal times. They don’t care about price.
This is a rational behavior because it makes little sense to spend limited capacity processing such information when prices are generally stable. There are more pressing issues to focus on.
But it also means that once inflation exceeds a certain threshold, it can suddenly become a big problem among people. Sustained price pressures can make inflation a hot topic in a matter of moments.
It’s like a light has been turned on. Such a threshold at which carelessness gives way to caution is quite different from the inflation threshold at which central banks estimate that their formal inflation target will be reached.
The costs of inflation primarily depend on whether prices are rising faster than nominal wages, whether purchasing power is redistributed among different social groups, or whether firms with market power sell at higher costs. It is analyzed from the perspective of whether it drives up the price of the product. . These fall into the area of economic or financial analysis.
However, inflation imposes not only economic costs on households, but also cognitive costs. A research paper on how people understand inflation, based on a survey of 3,055 people in the United States, by Alberto Binetti, Francesco Nuzzi, and Stefani Stancheva shows that people hate inflation. It should be read in conjunction with Stancheva’s earlier research on why.
One of the most obvious findings of their study is that high inflation complicates family decision-making. You need to readjust the basket of goods you buy, so you need to adjust your household costs. Higher prices complicate household decision-making. These cognitive costs that cause people to dislike inflation are not part of the standard analytical toolbox.
Economists have also traditionally focused on the “cost of shoe leather,” or the amount of money people wear out their shoes by walking around during times of high inflation. Two factors are at play here.
First, the opportunity cost of holding cash is higher when inflation is rising, so people are more likely to go to the bank to withdraw cash than to keep large sums of cash under their mattresses at home. I prefer
Second, when prices are rising, people are tempted to shop from store to store to find bargains. However, with the rise of digital banking and online commerce, these “shoe leather costs” are thought to have been minimized in modern times. Transaction costs are now much lower than before.
The broad result is that public behavior changes during episodes of high inflation, imposing both economic and cognitive costs on the population.
In a recent review of the two papers mentioned in this column, behavioral economist Robert Shiller, who first investigated similar issues in the late 1990s, wrote:
As Binetti-Nuzzi-Stantcheva points out, part of the explanation must be the fact that people are reminded almost daily about changes in retail prices when shopping. Wage increases are rare, and for many people, unemployment may be a once-in-a-lifetime event. ”
Although democracies like India are not immune to inflation shocks, political leaders are far more sensitive to price changes than those in wealthy countries that have generally had low inflation over the past three decades. They know from experience that high inflation has political costs.
