How Food Prices Shape Inflation Expectations and the Monetary Policy Response

We show that food price changes have a persistent impact on UK consumers’ inflation expectations. Over 60% of households report that their inflation perceptions are heavily influenced\r\nby food prices and display a stronger association between their inflation expectations and perceptions. In other words, households emphasising the importance of food prices tend to have\r\nmore backward-looking inflation expectations. We complement this finding with a Structural\r\nVector Autoregression (SVAR) analysis, illustrating that food price shocks have a larger and\r\nmore persistent effect on expectations compared to a “representative” inflation shock. Finally,\r\nwe augment the canonical New-Keynesian model with behavioural expectations that capture\r\nour empirical findings and show that monetary policy should respond more aggressively to food\r\nprice shocks.