K-State Research Shows Consumers Can Predict Inflation As Well As Professional Economists

    MANHATTAN, Kan., Aug. 25 /
EMWNews
/ -- When it comes to

predicting the rate of inflation, professional economists might tell

consumers, "Your guess is as good as mine."



    Research by a Kansas State University professor shows that household

surveys predict the inflation rate fairly accurately, and as well as

professional economists. The pros employ statistics like the unemployment

rate, money supply growth and exchange rate changes. Consumers

participating in surveys are more likely to think about how much they spent

at the grocery store that week.



    "Surprisingly, the median household is just as good as the average

professional economist," said Lloyd B. Thomas, head of the department of

economics at K-State, where he has been a faculty member since 1968. "I'm a

little surprised because economists are using sophisticated models. But the

consumers know what's happening with milk prices."



    Thomas and Alan P. Grant of Baker University in Baldwin City published

a study in the June issue of The Economic Record. They looked at the

accuracy of an inflation survey of U.S. consumers versus a survey of

Australians. Thomas said the U.S. survey was slightly more accurate, but

that could be because the U.S. survey -- which the University of Michigan

conducts each month by telephone with 500 households -- more accurately

probed consumers' hunches about inflation.



    Both surveys, however, showed that consumers have a good idea about

where inflation is headed. On average, they're off by 1.3 percentage

points. And although they don't get it exactly right, Thomas said they

weren't biased. That is, consumers don't consistently underestimate or

overestimate inflation.



    "It means economists need to improve their forecasting -- or at least

be a little humble," Thomas said.



    Inflation forecasts matter because they influence many areas of the

economy, from wage negotiations and the interest rate, to how businesses

set their prices. High inflation can mean businesses spend less on research

and development, fewer investors are willing to consider government bonds,

and people behave inefficiently, Thomas said. As examples, he said unions

spend time and money renegotiating more frequently, and governments and

businesses are forced to issue short-term bonds as buyers shy away from

long-term bonds.



    On a personal level, Thomas said inflation expectations can determine

whether people buy houses or how they manage their nest egg.



    "Inflation expectations are one of the most important factors in the

economic environment," Thomas said.



    He said persistent inflation didn't take hold in the United States

until after World War II. Before that, a loaf of bread cost about the same

in 1940 as it did in 1776. Commitment of government to prosperity and

Federal Reserve activism have meant that the price level in the U.S.

increased in 59 of the past 60 years. In the 1970s, inflation increased on

average 8 percent per year, Thomas said.



    In the past year, Thomas said rising food and gas prices have pushed

inflation above 5 percent. He said the Federal Reserve would normally need

to raise interest rates to slow down spending and inflation. But chairman

Ben Bernake and others on the Federal Reserve Board are fearful of a

recession.



    "Consumers make up 70 percent of total spending," Thomas said. "So if

consumers lose confidence, that could bring us into a bad economic

situation."



    As long-term inflation hedges, Thomas said it is wise to consider

investments in the stock market and real estate.



    "When there's rising inflation, it's beneficial to be in debt to

purchase real assets, because you'll pay your debt back with money that

won't be worth as much in the future," Thomas said.



    Whereas high inflation helps those who hold real estate and other real

assets, it hurts people with bonds. This often includes people with

retirement accounts.



    "With high inflation, you want to avoid bonds like the plague," Thomas

said.