Understanding inflation expectations uncertainty in the euro area. Does psychology help? (original) (raw)

This study is motivated by the recent increase in volatility of both inflation and inflation expectations, triggered initially by the surge in commodity prices and more recently by the global economic crisis. Uncertainty about future inflation may pose a problem both for monetary policy and for economic efficiency at large. Our study shows that various strands of economic theory offer possible explanations for the mechanisms behind the formation of inflation expectations and uncertainty, spanning from extensions of the rational expectations model to behavioral economics theories. Our econometric estimations suggest that heuristics may indeed influence consumers’ inflation expectations uncertainty. For instance, consumers seem to invest more effort in forming expectations about future inflation if and when inflation developments become more salient. However, for very large inflation shocks this effect seems to be dampened by other behavioral features that may affect how agents form e...