The recent surge in inflation has raised concerns about its potential long-term impact on Generation Z, with new research indicating that this demographic may carry deep psychological scars and persistently fear rising prices. These findings could present challenges for central bankers in the years ahead.
In the United Kingdom, young people have experienced double-digit price growth for the first time, leading to heightened expectations of continued high inflation among Generation Z, according to Bloomberg’s analysis of Bank of England data. This poses a dilemma for policymakers aiming to maintain a 2% inflation target by discouraging wage increases.
“Inflation expectations have risen significantly among young people,” noted Michael Saunders, a senior adviser at Oxford Economics and former Bank of England rate-setter, regarding the British context. He emphasized, “It’s reasonable to expect there will be some scarring on inflation expectations,” as the younger generation’s outlook on inflation may expand beyond the previously perceived 2% or 3%.
Historically, younger generations have held lower inflation expectations compared to older age groups who recall the surges in prices during the 1970s and 1980s. However, recent analysis of UK data reveals that inflation expectations among those aged 16 to 24, part of Generation Z, have risen more dramatically than any other age group since the onset of the pandemic and the Ukraine conflict, which triggered price hikes.
Evidence from Europe further suggests that the psychological impact of high inflation can be inherited across generations, with research on the Federal Reserve in the United States indicating that even central bankers may be influenced by their inflation experiences.
This research is pivotal as it sheds light on the formation of inflation expectations and how extended periods of higher prices can reshape individuals’ perspectives. These expectations play a crucial role in influencing wage demands and, subsequently, price-setting by businesses—a key challenge for policymakers who aim to anchor these expectations around 2%.
Economists refer to this phenomenon as an “experience effect,” where individuals who lived through periods of volatile and high price growth in the past have those memories deeply embedded in their thinking. Until the pandemic, inflation in the US and Europe had remained subdued for three decades, having little impact on the Millennial and Gen X generations, aged 27 to 58. However, current data from the UK suggests that Generation Z is now anticipating higher inflation than older age groups.
An analysis of a Bank of England survey underscores that Britons aged 16 to 24 witnessed the most substantial increase in inflation expectations even before high inflation became a major concern for central banks. This demographic, previously the least likely to expect price increases exceeding 3% in August 2020, has now become the second-most likely group to hold such expectations, trailing only those aged 55 to 64, who grew up during a period of high and volatile inflation.
Sanjay Raja, Chief UK Economist at Deutsche Bank, emphasized, “The longer inflation remains above target, the higher inflation expectations will run across all age groups, with younger generations likely to adjust their expectations the most.”
Research by Ulrike Malmendier, a professor of economics at the University of California in Berkeley, underscores the significant impact of dramatic economic experiences, such as high inflation and spikes in unemployment, on individuals’ belief formation for years to come.
Countries that experienced severe inflation, such as the UK and parts of the eurozone, are at greater risk of witnessing a shift in consumer behavior due to this experience effect. It can result in positive outcomes, such as increased savings by consumers.
Malmendier’s research also suggests that the experiences of Federal Reserve rate-setters in the US regarding inflation can shape their monetary policy leanings. This implies that future central bankers could be influenced by their post-pandemic experiences with inflation.
Additionally, a study by Fabio Braggion, a professor of finance and financial history at Tilburg University, indicates that the psychological impact of inflation can be passed down through generations. European households that endured hyperinflation before 1930 have inflation expectations today that are 1.4 percentage points higher than countries that did not experience such inflation.
Braggion suggests that there may be “something cultural” about these inflation expectations, possibly influenced by intergenerational discussions and institutional factors such as local media coverage.
The convergence of inflation expectations among younger and older generations could pose challenges for central bankers, particularly in a post-COVID and geopolitically uncertain environment. Policymakers anticipate more volatile inflation patterns after a period of unusual stability, potentially leading to shifts in inflation expectations among younger generations previously unaffected by rising prices.
Michael Saunders summed up the situation, stating that a world with more adverse supply shocks would likely cause inflation expectations to settle above target rates, thereby complicating central bankers’ efforts to restore inflation to target levels.
