Household expectations are usually thought to play a central role in the transmission of macroeconomic policy. Yet we still know too little about how households perceive and interpret the complex relationships and feedback between relevant economic variables that are at the core of general equilibrium. In a recent project (Ferreira and Pica 2025), we use new euro area household level survey data to show that households interpret contractionary demand and supply shocks as inflationary, contrary to conventional macroeconomic models. Our paper contributes to a recent literature investigating households’ mental models about economic relationships (e.g. André et al. 2022, Piccolo et al. 2025).
The misalignment we uncover emerges consistently across time, countries, demographic groups, and levels of financial literacy. Although disagreement is pervasive, there is a clear structure in household expectations: two common factors explain a large share of the variation in beliefs within and across individual households in different countries.
These patterns challenge standard assumptions in macroeconomic models and raise important questions about the communication and effectiveness of monetary policy. When central banks raise interest rates, they do so partly to influence expectations. However, if households’ understanding of and attention to transmission mechanisms differ from those assumed in the models that justify such rate changes – and if the households act on these beliefs – the impact of a policy may diverge from its intended effect. The links between expectations, real outcomes, and monetary policy has been explored in other Vox columns (e.g. Gorodnichenko et al. 2019, 2021, Weber et al. 2021).
The effect of aggregate demand and supply shocks on expectations
A natural way to explore the mental models that households entertain about economic dynamics is to evaluate the impact that exogenous shifts in demand and supply curves have on beliefs. Under rational expectations, these shifts should affect expectations about prices and quantities in a specific direction. We study how households in six major euro area economies – Belgium, France, Germany, Italy, the Netherlands, and Spain – respond to aggregate shocks using the ECB’s high-frequency Consumer Expectations Survey. This monthly panel captures detailed, household-level expectations about inflation, unemployment, interest rates, the general economic outlook, and other variables.
Our first key finding is that contractionary monetary policy shocks raise inflation expectations. Specifically, following an ECB rate increase, households expect not only slower economic growth and higher unemployment, but also higher inflation over the next 12 months (Figure 1). This response is surprising. In textbook New Keynesian models, tighter monetary policy reduces demand and dampens inflation. Households’ expectations in our data move in the opposite direction and do so persistently. This result is in line with André et al. (2022) and Piccolo et al. (2025). One of our contributions to this literature is to validate these results internally across different identification strategies – including an event-study around ECB meetings – using alternative data sources going back to 2000. In addition, we show a surprising robustness across countries and demographic groups.
Figure 1 Impulse responses of household expectations to a contractionary monetary policy shock
Note: Impulse response functions of household expectations following a contractionary monetary surprise that raises the short rate by 25 basis points on impact. These responses are estimated using the panel local projections with Newey-West standard errors clustered at the monthly level. The 95% confidence intervals are shown in light blue; the 68% confidence intervals in dark blue. The estimation sample spans April 2020 to January 2024 for all variables except interest rate expectations, which are available from September 2020 onward.
Turning to oil shocks, household-level responses align closely with the expected effects of a stagflationary shock: a rise in the real oil price leads to higher expected inflation while lowering expected economic growth (Figure 2).
We therefore conclude that households consistently interpret contractionary supply and demand shocks as inflationary.
Figure 2 Impulse responses of household expectations to a contractionary oil shock
Notes: Impulse response functions of household expectations following a contractionary oil shock that raises the real oil price by 10% on impact. These responses are estimated using panel local projections with Newey-West standard errors clustered at the monthly level. The 95% confidence intervals are shown in light blue; the 68% confidence intervals in dark blue. The estimation sample spans April 2020 to June 2024 for all variables except interest rate expectations, which are available from September 2020 onward.
Common drivers of beliefs
Despite significant and persistent disagreement, household expectations move together in systematic ways. We uncover two latent drivers (principal components) that explain around 40% of the variation in expectations across households and countries.
The first component reflects a broad perception that inflation is bad for the economy due, for example, to its origin on supply side shocks or to its erosion of disposable real incomes (Kamdar and Ray 2024, Binetti et al. 2024). Households that expect higher inflation also anticipate slower growth and weaker labour markets. This ‘inflation pessimism’ dominates the structure of expectations and suggests a mental model wherein price increases are interpreted as a sign of worsening real conditions.
The second component captures concerns about interest rates and unemployment. Households that expect higher interest rates also expect weaker economic outcomes, suggesting that they associate rate hikes with cost increases and labour market deterioration, rather than with disinflationary effects.
Strikingly, these latent drivers are not systematically linked to observable characteristics like age, education, housing tenure, or financial literacy. Nor are they specific to any one country. This points to a shared cognitive framework – a simplified but common view of the business cycle – that shapes how households interpret macroeconomic developments.
Building on this, we estimate a two-factor structure for the cross-section of all expectations. The structure is general enough to capture individual time-invariant biases and disturbances, and can be mapped onto most equilibrium models with a generalised expectation formation process. The first factor, which explains the bulk of the time-series variation, tracks inflation-related sentiment potentially emerging from attention to media outlets, including the supply bottlenecks of 2021, the energy crisis, and ECB rate hikes from mid-2022 onward. The second factor correlates closely with unemployment dynamics, suggesting that demand-side perceptions are linked primarily to real activity (Figure 3).
Figure 3 Evolution of identified factors over the sample period
Note: Figure plots factors identified through sign restrictions on household expectations data; sample covers the period from September 2020 to December 2024. The two thick lines represent the optimal uncorrelated factors, identified using a standard Euclidean metric. The thinner lines show the 10th, 25th, 50th, 75th, and 90th percentiles of the distribution of distances for alternative valid models (i.e. rotations). Blue lines correspond to the first factor, identified by loadings that capture opposite correlations between expected economic growth and expected inflation. Red lines correspond to the second factor, identified based on demand-type signs on expected economic growth and expected inflation. Vertical solid lines mark key events: (1) disruptions in the Suez and Panama Canals (May 2021), (2) the Russian invasion of Ukraine (February 2022), and (3) the ECB’s first post-pandemic interest rate hike (July 2022).
Conclusions and implications for policy
Understanding how households interpret macroeconomic policy is vital for the effectiveness of central bank action. Our study shows that households often react in ways that contradict the standard theoretical playbook. This misalignment is systematic and rooted in a shared structure of beliefs, not idiosyncratic noise.
These findings have important implications. If households believe that contractionary monetary policy fuels rather than curbs inflation, then standard policy levers may be less effective than models suggest. Communication strategies that rely on rational expectations may fall flat if the public’s mental model of the economy diverges fundamentally from that of policymakers.
Moreover, if inflation expectations are not anchored by policy signals but are instead shaped by perceived cost pressures, there is a risk of self-fulfilling inflation dynamics. Policymakers may inadvertently reinforce inflation fears if rate hikes are seen as signs of economic trouble rather than tools to stabilise prices.
Our evidence suggests that households interpret shocks through a lens shaped by recent crises – such as the energy shock following Russia’s invasion of Ukraine – and by deep-rooted concerns about real purchasing power. Addressing these perceptions may require more than technical briefings or forecasts. Clear, relatable narratives about how policy affects inflation and the broader economy are essential.
References
Andre, P, C Pizzinelli, C Roth and J Wohlfart (2022), “Subjective Models of the Macroeconomy: Evidence from Experts and Representative Samples”, Review of Economic Studies 86(6): 2958–91.
Binetti, A, F Nuzzi and S Stantcheva (2024), “People’s understanding of inflation”, Journal of Monetary Economics 148, 103652.
Coibion, O, Y Gorodnichenko and M Weber (2022), “Monetary Policy Communications and Their Effects on Household Inflation Expectations”, Journal of Political Economy 130(6): 1537–84.
Ferreira, C and S Pica (2005), “Households’ Subjective Expectations: Disagreement, Common Drivers, and Reaction to Monetary Policy”, Banco de Espana Working Paper No. 2445.
Gorodnichenko, Y, M Weber and O Coibion (2019), “Monetary policy communications and their effects on household inflation expectations”, VoxEU.org, 22 February.
Gorodnichenko, Y, M Weber and O Coibion (2021), “How inflation expectations affect households’ spending decisions”, VoxEU.org, 19 March.
Kamdar, R and W Ray (2024), “Attention-Driven Sentiment and the Business Cycle”, University of Oxford Working Paper.
Piccolo, J, A Russo, E Granziera and E Castelnuovo (2025), “Households’ Macroeconomic Beliefs: The Role of Education”, Marco Fanno Working Paper 316, Universita Degli Studi di Padova.
Weber, M, G Kenny, D Georgarakos, Y Gorodnichenko and O Coibion (2021), “The effect of macroeconomic uncertainty on household spending”, VoxEU.org, 31 July.
