The Inflation Attention Threshold and Inflation Surges

TL;DR

This paper investigates how public attention to inflation changes at a specific threshold, influencing inflation dynamics and the persistence of inflation surges, with implications for macroeconomic policy.

Contribution

It introduces an inflation attention threshold model that explains the persistence and asymmetry of inflation following shocks, based on attention dynamics.

Findings

Attention doubles when inflation exceeds 4%

High attention amplifies inflationary effects of supply shocks

Attention increases explain half of 2021 inflation surge

Abstract

At the outbreak of the recent inflation surge, the public's attention to inflation was low but increased quickly once inflation started to rise. In this paper, I quantify when and by how much the public's attention to inflation changes, and derive the macroeconomic implications of these attention changes. I estimate an attention threshold at an inflation rate of about $4%$, and that attention doubles when inflation exceeds this threshold. Adverse supply shocks become more inflationary in times of high attention, and the increase in people's attention to inflation in 2021 accounts for half of the subsequent supply-driven inflation. I develop a model accounting for the attention threshold and show that shocks that are usually short lived lead to a persistent surge in inflation if they induce an increase in people's attention. The attention threshold further lengthens the last mile of disinflation after an inflation surge, and leads to an asymmetry in the dynamics of inflation.