Abstract: We use an account-level dataset from Estonia to study the effects of personally experienced inflation on households’ financial decisions. By exploiting households’ differential exposure to inflation over time we find that personally experienced price growth affects consumption beyond the impact of headline inflation. We estimate that a 1 p.p. increase in quarterly experienced inflation leads to a sizeable 6 percent increase in real spending. We explain the results by different mechanisms at work such as intertemporal consumption allocation and money illusion. Additionally, we find that households react to higher experienced inflation with increasing large purchases while they use savings and consumer loans to finance increased spending. Our findings are important for policy-makers by showing that aggregate effects of inflation on spending are heterogeneous across population subgroups. Hence, real effects of monetary policy depend on the composition of headline inflation and distributional characteristics of the population.

Keywords: Experienced inflation, consumption, saving, money illusion, intertemporal choices

JEL-codes: D14, D15, E21, E3

Authors:

Christoph Basten - University of Zurich, Swiss Finance Institute and CESifo 
Merike Kukk - Department of Economics and Finance, Tallinn University of Technology; Bank of Estonia 
Jan Toczynski - University of Zurich and Swiss Finance Institute 

The public research seminars of the Department of Economics and Finance (DEF) at Tallinn University of Technology  usually take place on the second and fourth Wednesdays of the month in both onsite and online format, unless announced otherwise. The presentation will last approximately 45 minutes followed by 15 minutes of discussion. The seminars are held in English. Copies of the paper are usually made available at the seminar. The DEF seminar series is organised in collaboration with the project ”Individual Behaviour and Economic  Performance: Methodological  Challenges and Institutional Context” (IBEP), which has received funding from the European Union’s Horizon 2020 Research and Innovation programme under Grant Agreement No 952574. Questions about the seminar can be sent to the IBEP seminar coordinator Kadri Männasoo, kadri.mannasoo@taltech.ee.