The Shadow Cost of Inflation: How Expectation Errors Affect People’s Consumption Decisions and Mental Health

While the impact of realized inflation on household welfare is traditionally modeled through the budget constraint, the transmission of subjective inflation expectations to financial security and mental well-being remains relatively underexplored. Drawing on behavioral theories of affect-cued recall and cognitive simulation, this thesis hypothesizes that inflation expectation errors impose real economic and psychological costs on households, distinct from the effects of realized price shocks. This hypothesis is tested by imputing inflation expectations from the New York Fed Survey of Consumer Expectations (SCE) onto the U.S. Census Household Pulse Survey using Optimal Transport (OT) weights. This novel synthetic dataset links granular belief data with high-frequency measures of food spending behavior, and mental health. The analysis reveals a striking asymmetry: households that over-forecast inflation engage in precautionary food stockpiling and bear a behavioral cost even when their nominal budget constraint remains intact. On the other hand, households that under-forecast inflation face a realization shock causing them to cut grocery and restaurant spending and suffer pronounced psychological distress. This psychological burden is statistically robust across middle-income cohorts and directionally largest among the lowest-income households, who lack the liquidity to absorb unanticipated shocks. These findings underscore a policy implication: central bank communication strategies that anchor inflation expectations generate a positive policy externality by mitigating both unnecessary consumption contractions and the material and mental health costs of financial surprise.