Financial literacy and the impact of central bank communication on consumer inflation expectations

This study examines how financial literacy influences the formation of household inflation expectations in response to central bank communication. Using sentiment analysis of FOMC statements and microdata from the New York Fed's Survey of Consumer Expectations, our analysis finds that individuals with higher financial literacy, particularly strong numeracy, respond more moderately to shifts in monetary policy tone. While hawkish statements are generally associated with higher inflation expectations and dovish statements with lower expectations, consistent with a Fed information effect, this relationship is significantly less pronounced among financially literate respondents. Our results suggest that numeracy, rather than general financial knowledge, explains differences in responsiveness. Our findings emphasize the role of cognitive ability in shaping how individuals interpret monetary policy signals. From a policy perspective, promoting numeracy through financial education may improve expectation formation and support more effective transmission of monetary policy.