Key findings
- This Note presents empirical evidence suggesting that New Zealand households tend to pay more attention to inflation when it is high than when it is low. In the academic literature, this is known as rational inattention.
- Rational inattention can result in a non-linear relationship between actual inflation and households’ inflation expectations. Once inflation rate rises above a certain threshold, for example, 2%, household inflation expectations line up closely with actual inflation. Thus, inflation expectations may be slow to respond to monetary policy announcements, and this may make it more difficult for the central bank to rein in high inflation by raising interest rates.
- It is important for monetary policymakers to monitor this potential non-linearity in how households perceive and internalise inflation data.
The Analytical Notes series encompasses a range of background papers prepared by Reserve Bank staff. Unless otherwise stated, views expressed are those of the authors, and do not necessarily represent the views of the Reserve Bank.
Why we did this research
Inflation expectations — what people think inflation will be in a year or several years from now — play a vital role in driving actual inflation. Hence, well-anchored inflation expectations are often seen as a sign of the credibility of inflation-targeting monetary policy. We closely monitor how people think prices will change in the future and aim to manage these expectations.
The Monetary Policy Remit outlines the goals of monetary policy for:
- medium-term price stability
- maximum sustainable employment
- soundness of the financial system
- avoiding unnecessary instability in output, interest rates and the exchange rate.
This Analytical Note is also in line with our Statement of Intent.