Finance Seminar Arna Olafsson

The paper looks at why higher inflation expectations don't always translate into the spending shifts that monetary policy theory predicts. The authors combine Icelandic bank records with a survey that measures decision-making ability (DMA) through consistency violations in an incentivized choice task. Households with high DMA shift durable purchases forward when they expect more inflation, as theory would predict, while low-DMA households move in the opposite direction. This pattern shows up in hypothetical decision scenarios as well as real spending, and it holds even after accounting for how precise people's beliefs are.

The same ability measure also predicts stock-market participation, overdraft use, and holding costly debt alongside idle savings.

Takeaway: Decision-making ability, not just belief formation, shapes whether households respond to inflation the way theory predicts.