To be sure, the extent of the upward bias can vary. According to the Federal Reserve Bank of Cleveland research mentioned above, people with high incomes estimated lower levels of inflation than those with low incomes, and there were similar estimation differences between married people vs. singles, whites vs. nonwhites, middle-aged people vs. young people, and perhaps most strikingly, men vs. women, controlling for other factors. While men on average estimated inflation at 4.6 percent, women thought it was 6.9 percent; curiously this gap wasn’t explained by differences in the items purchased or ignorance of the CPI.
There are a range of potential reasons for these discrepancies, but suffice it to say, they reinforce the notion that perceptions of inflation often don’t match the truth, and one’s personal experiences can help explain this.
Media stories about inflation can help correct biased inflation perceptions. This is good news, since perceiving inflation as greater than it actually is has real implications for investing.
For example, all else equal, the higher an individual’s assessment of inflation, the lower may be his or her assessment of real yields. Such inflation hawks are more inclined to borrow rather than invest at nominally fixed long-term rates. Their portfolios may also suffer from excessive exposure to investments that may not be optimal for the prevailing economic environment, including inflation hedges such as Treasury Inflation Protected Securities (TIPS); real assets such as real estate; and commodities like gold.
Sources: Linked to throughout post
Nelli Oster, PhD, is a Director and Investment Strategist in BlackRock’s Multi-Asset Strategies Group. She writes about behavioral finance for The Blog.