Consumers Predict Inflation as Accurately as Economists

Consumers are just as good as professional economists at predicting the rate of inflation, a new survey finds.

The inflation rate is the percentage increase in the prices of goods and services, and forecasts of the rate influence everything from interest rates to wage negotiations to decisions on whether a person buys a home.

In the past year with rising food and gas prices, the inflation rate has reached 5.5 percent, meaning on average prices have increased by that much between July 2007 and July 2008. For comparison, between 1996 and 2006, the average inflation rate was about 2.5 percent, and in 2007 it rose to 4.4 percent, according to the researchers.

The survey results, detailed in the June issue of the journal The Economic Record and announced this week, suggest the everyday shopper has expertise in one key area, even though the pros employ statistics such as the unemployment rate, money supply growth and exchange rate changes. Instead of computers and stats, consumers think about their latest grocery bills.

"I'm a little surprised because economists are using sophisticated models," said Lloyd Thomas, head of the Department of Economics at Kansas State University, "but the consumers know what's happening with milk prices."

Thomas and Alan Grant of Baker University in Kansas analyzed surveys of U.S. and Australian consumers collected from 1978 through 2005. For the U.S. data they used the Michigan Survey, which involves monthly telephone interviews with 500 households. The U.S. respondents were asked several questions, including how much prices will go up or down in the next 12 months.

On average, the consumers predicted inflation rates that were off by 1.1 percentage points. The researchers compared the results with those found with the Livingston Survey of professional economists, finding a similar error in predictions.

For instance, from 1993 through 2005, U.S. consumers as a whole were off by an average of 0.72 percentage points in forecasting the inflation rate. Over that same period, economists erred by about 0.82 percentage points.

"It is amazing that economists on the average cannot out-forecast households," Thomas said.

How do they do it?

"I think it's partly because inflation is hard to forecast. Even the weather plays a part," Thomas told LiveScience. "I think some of these basic things that affect prices nobody can forecast, households or professional economists." In addition to weather (a variable that can include the impact of droughts), energy prices play a big role.

Even still, the everyday consumer has plenty of data points to go on. "Households are right there in the nitty-gritty seeing what groceries are doing when they go to the store, seeing what gas prices are doing," Thomas said.

So what's in store for next year? "Households are forecasting inflation in the next year will be 5.1 percent," Thomas said, "and that's a little bit scary because inflation has a lot of negative influences on the economy. When you have high inflation some people really get hurt by it if they happen to be on a fixed income."