How Have Inflation Expectations Differed by State?

Inflation is frequently a hot topic in economic news, with measures based on the consumer price index and the price index for personal consumption expenditures among the most popular. However, inflation expectations, the rate at which people and businesses expect prices to increase, are also an important indicator of economic health, and they can often reveal insights that other measures of inflation do not necessarily capture. In this blog post, I look at inflation expectations by state to see which states had the highest inflation expectations in the three years following the end of the COVID-19 recession.

How Does Inflation Impact Consumers?

Inflation—which refers to a general, sustained upward movement of prices for goods and services in an economy—has always been an important issue for U.S. households. High levels of inflation erode purchasing power, meaning that households can’t buy as much as they could before with the same amount of money. Frequently, this means spending more money to get the same quality of food, housing and transportation, or switching to cheaper alternatives, such as store-brand food products, moving to a cheaper apartment or taking the bus instead of driving to work.

Inflation also affects longer-term financial decisions. For instance, think about lending money. When there’s inflation, the money a lender eventually receives will be worth less than the money that was originally lent out. Lenders try to compensate for this by charging higher interest rates, but if inflation ends up being much higher than they initially expected, they can still lose money.

Why Are Inflation Expectations Important?

While inflation itself is clearly important to households and businesses, what they think inflation will be in the future is also important. For example, if lenders suspect inflation will be higher in the future, they will demand a higher interest rate to lend today. This makes borrowing more expensive, increasing the cost of mortgages, student loans, car loans and other important expenses.

Inflation expectations can also influence future inflation itself. If consumers expect prices to rise sharply in the future, they may try to buy more now before inflation hits. This increased demand would then prompt producers to raise prices, causing the very inflation consumers were trying to avoid.

Consequently, the Federal Reserve carefully tracks measures of inflation expectations along with measures of actual inflation.

Tracking Inflation Expectations by State

One source for inflation expectations data is the New York Fed’s Survey of Consumer Expectations (SCE), which surveys nationally representative heads of households from all 50 states. The SCE asks respondents what they expect the national rate of inflation to be over the next twelve months, among other questions.

The map below shows responses from the 50 states from May 2020 (after the end of the COVID-19 recession, which officially lasted from February to April 2020) until April 2023, the last available month of data. For each state, I plotted the weighted median across time and respondents (using the weights provided by the SCE) to limit the impact of respondents, as well as months, whose predictions are substantially different from the norm. This is particularly important for states with smaller populations, which also survey fewer individuals and can thus be more influenced by individual outliers in the sample. A weighted median is a way of measuring the central tendency that takes into account the importance, or weight, of each value in the dataset.

Inflation Expectations One Year Ahead by State: May 2020-April 2023

SOURCES: New York Fed’s Survey of Consumer Expectations and author’s calculations.

NOTES: The map shows one-year-ahead expected inflation from May 2020 to April 2023. The weighted median across time and respondents is shown for each state.

As can be seen, respondents from Arkansas, Mississippi and Tennessee had the highest inflation expectations over this period. Respondents in these three states expected year-ahead inflation to be 9.5%, 9.0% and 8.9%, all significantly above the state median of 4.9% during that period. While those expectations came down somewhat as inflation eased, they were still higher than actual inflation over the entire period.

Why Might Inflation Expectations Differ among States?

At first glance, the three states whose residents had the highest inflation expectations might be surprising. One might think inflation expectations would be higher in states with high rates of population growth, because those states tend to have higher inflation, with housing prices rising to meet the new demand. While the populations of Arkansas and Tennessee grew faster than the national average from 2020 to 2022, the population of Mississippi actually declined during this period, according to the Census Bureau. On the other hand, New Hampshire, whose respondents had the lowest inflation expectations in the country, actually grew faster than Arkansas and nearly as fast as Tennessee.

High inflation also tends to increase inflation expectations, as individuals expect the higher inflation to continue into the future. To measure state-level inflation, I used the mean year-over-year change between 2020 and 2022 in the implicit regional price deflator from the Bureau of Economic Analysis. While inflation rates in Mississippi and Tennessee were slightly above national averages, so was the inflation rate in New Hampshire, which had the lowest inflation expectations. Thus, there seems to be little connection between state-level inflation and state-level expectations of national inflation.

What might help explain these results? It is important to remember that inflation expectations are fundamentally a measure of how individuals feel about the economy and inflation specifically. Those who are less wealthy tend to experience the most hardship from inflation, in part because they tend to have less savings and less ability to borrow money in times of financial strain. Consequently, individuals in less wealthy states may feel the decline in real, or inflation-adjusted, income the most, even if the actual state-level inflation rate isn’t much higher than the national average. According to the Bureau of Economic Analysis, Arkansas and Mississippi are in the bottom 10 states, and Tennessee is 17th from the bottom, in terms of per capita personal income, averaged between the second quarter of 2020 and the second quarter of 2023. In contrast, the two states with the lowest inflation expectations, New Hampshire and North Dakota, had incomes per capita that were among the highest.

Another factor that might help explain higher inflation expectations in Arkansas is that the state caps tax bracket inflation adjustments at 3%. This means that during times of high inflation, some individuals move into higher tax brackets as their nominal (not adjusted for inflation) wages increase. Effectively, this means they have to pay higher taxes relative to income, since their real (adjusted for inflation) wages haven’t kept pace with inflation. Since inflation expectations are ultimately the product of how individuals feel about the economy, the larger impact of inflation on Arkansas residents might have led to more pessimistic expectations compared with those of residents in states with no cap on inflation adjustments.

To put this in perspective, suppose a resident of Arkansas was earning $49,000 per year at the end of the COVID-19 recession. If inflation had truly been 9.5% each year over the next three years, without any wage gains the purchasing power of that same wage would have been barely $37,000. In other words, inflation would have eroded about a quarter of that person’s purchasing power as his or her real income declined. People do typically experience wage growth during periods of inflation, and it is important to remember that most measures of inflation were generally less than 9.5% year-over-year from 2020 to 2023. However, this example shows the type of economic hardship the SCE respondents from Arkansas might have been expecting.

Taking Inflation Expectations into Account

In conclusion, inflation expectations increased nationwide in the three years following the end of the COVID-19 recession, although expectations differed across states. People in Arkansas, Mississippi and Tennessee had the highest inflation expectations during this period. While these states’ population growth and inflation rates (both significant drivers of inflation expectations) were not much higher than national averages, the relatively low per capita incomes in these states meant that residents likely felt the hardship of inflation more than residents of higher-income states did.

Given the significant impact inflation expectations can have on other economic variables, it is important to observe measures that capture how consumers feel about and perceive the economy in addition to concrete economic variables. Doing so can help someone get a more complete picture of the overall health of the economy.