The Bank of England's regular survey of public attitudes to inflation is likely to report next week that people expect inflation to rise sharply this year.
I say so for a simple reason. There's a strong correlation between people's expectations of inflation in the next 12 months and their perceptions of inflation in the last 12 months. The correlation between the two has been 0.88 since the Bank's survey began in 1999, with the coefficient on past inflation being 0.6. This suggests inflation expectations seem to follow a rule of thumb: expect future inflation to be the same as past inflation, but adjust upwards if inflation has recently been unusually low and downwards if it has been unusually high.
With inflation having risen recently, this points to inflation expectations also rising.
This is worrying for a simple reason: the public's inflation expectations are a pretty good guide to future inflation. The correlation between expected inflation and perceived inflation 12 months later has been 0.69 since data began. Many of the differences between the two were due to genuinely unforeseeable shocks such as rising oil prices in 2007 and falling ones in 2014.
When households tell us that inflation will rise, we should therefore heed the message.
Which brings us to a puzzle: what is the mechanism through which expected inflation leads to actual inflation?
Here, I had expected to write that it's wages: when households expect high inflation, they demand higher wages to protect themselves from it, and rising wages are associated with rising prices. This seems like common sense.
But it doesn't fit the facts. Expected inflation is actually negatively correlated with wage growth in the subsequent 12 months: this is true both for the raw correlation and if we control for unemployment. High inflation expectations don't lead to rising wage growth. If anything the opposite. This might simply be because workers since 2000 have lacked the power to get wage rises.
So, what other mechanisms link expected inflation to actual future inflation?
One possibility is causality. Companies share households' expectations and so when they expect prices to rise they actually put prices up, in anticipation of both rising costs and of their rivals doing so.
But there's another possibility. It's simply that households accurately foresee changes in inflation. The dispersed, fragmentary and partial knowledge that each individual has about local and particular economic conditions aggregates into a wisdom of crowds. Just as households' spending decisions can predict future economic growth, so households in aggregate have foresight about inflation.
Sometimes - and under very particular conditions - the people can do better than experts. And sometimes, simple rules of thumb such as that which seems to fit inflation expectations can perform quite well. Investors should therefore pay close attention to what the public thinks will happen to inflation - because ordinary people are sometimes good economic forecasters.
