Inflation expectations and learning about monetary policy (original) (raw)
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Information-Based Heterogeneity in Expectations and Optimal Monetary Policy
SSRN Electronic Journal, 2012
This paper analyses optimal monetary policy and welfare implications of three endogenous processes in forming inflation expectations, which depart from the standard case of rational expectations. Two processes assume heterogeneous expectations driven either by discretionary central banks through the release of information or by agents through discrete choice among two forecast rules; the third process is a Bayesian learning about the central bank's inflation target. Transitional dynamics towards steady-state show that, overall, an active and transparent monetary policy promoting rationality and learning may raise welfare during disinflations, while a passive and less transparent attitude may stabilise output and raise welfare through inflationary surprises.
Trust, but verify. De-anchoring of inflation expectations under learning and heterogeneity
2017
The paper studies how a prolonged period of subdued price developments may induce a de-anchoring of inflation expectations from the central bank's objective. This is shown within a framework where agents form expectations using adaptive learning, choosing among a set of alternative forecasting models. The analysis is accompanied by empirical evidence on the properties of inflation expectations in the euro area. Our results also suggest that monetary policy may lose effectiveness if delayed too much, as expectations are allowed to drift away from target for too long. JEL Classification: E31, E37, E58, D83
The role of expectations in economic fluctuations and the efficacy of monetary policy
Journal of Economic Dynamics and Control, 2005
This paper investigates the role that imperfect knowledge about the structure of the economy plays in the formation of expectations, macroeconomic dynamics, and the efficient formulation of monetary policy. Economic agents rely on an adaptive learning technology to form expectations and to update continuously their beliefs regarding the dynamic structure of the economy based on incoming data. The process of perpetual learning introduces an additional layer of dynamic interaction between monetary policy and economic outcomes. We find that policies that would be efficient under rational expectations can perform poorly when knowledge is imperfect. In particular, policies that fail to maintain tight control over inflation are prone to episodes in which the public's expectations of inflation become uncoupled from the policy objective and stagflation results, in a pattern similar to that experienced in the United States during the 1970s. Our results highlight the value of effective communication of a central bank's inflation objective and of continued vigilance against inflation in anchoring inflation expectations and fostering macroeconomic stability.
Inflation Expectations, Adaptive Learning and Optimal Monetary Policy
Handbook of Monetary Economics, 2010
This chapter investigates the implications of adaptive learning in the private sector's formation of inflation expectations for the conduct of monetary policy. We analyze the determinants of optimal monetary policy in the standard New Keynesian model, when the central bank minimizes an explicit loss function and has full information about the structure of the economy, including the precise mechanism generating private sector's expectations. The focus on optimal policy allows us to investigate how and to what extent a change in the assumption of how agents form their inflation expectations affects the principles of optimal monetary policy. It also provides a benchmark to evaluate simple policy rules. We find that departures from rational expectations increase the potential for instability in the economy, thereby strengthening the importance of managing (anchoring) inflation expectations. We also find that the simple commitment rule under rational expectations is robust when expectations are formed in line with adaptive learning.
Heterogeneous Inflation Expectations and Learning
Journal of Money, Credit and Banking, 2015
Using the panel component of the Michigan Survey of Consumers, we estimate a learning model of inflation expectations, allowing for heterogeneous use of both private information and lifetime inflation experience. "Life-experience inflation" has a significant impact on individual expectations, but only for one-year-ahead inflation. Public information is substantially more relevant for longer-horizon expectations. Even controlling for life-experience inflation and public information, idiosyncratic information explains a nontrivial proportion of the inflation forecasts of agents. We find that women, ethnic minorities, and less educated agents-groups with perennially high inflation expectations-have a higher degree of heterogeneity in their idiosyncratic information and give less importance to recent movements in inflation. During the 1990s and early 2000s, consumers have believed inflation to be more persistent in the short term. However, quarterly inflation fluctuations have a smaller effect on long-term inflation expectations, especially in recent years, suggesting that agents believe shocks to be temporary.
Inflation Expectations and Monetary Policy Surprises
The Scandinavian Journal of Economics
We use monthly data across 15 euro area economies for the period 1985:1-2015:3 to obtain monetary policy changes that can be regarded as surprises for different types of consumers. A novel feature of our empirical approach is the estimation of monetary policy surprises based on changes in monetary policy that were unanticipated according to consumers' stated beliefs about the economy. We look at how these surprises affect consumers' inflation expectations. We find that such monetary policy surprises can have the opposite impact on inflation expectations to those obtained under the assumption that consumers are well-informed about a set of macroeconomic variables describing the state of the economy. When we relax the latter assumption and focus instead on consumers' stated beliefs about the economy, unanticipated increases in the interest rate raise inflation expectations before the crisis. This is consistent with imperfect information theoretical settings where unanticipated increases in interest rates are interpreted as positive news about the state of the economy by consumers that know policymakers have relatively more information. This impact changes sign since the crisis and varies, e.g. across low versus high-income consumers in a manner consistent with the latter becoming rationally attentive in a period during which signal extraction is presumably more difficult and the incentive to extract information greater.
Monetary Policy Under Behavioral Expectations: Theory and Experiment
SSRN Electronic Journal, 2015
Expectations play a crucial role in modern macroeconomic models. We replace the common assumption of rational expectations in a New Keynesian framework by the assumption that expectations are formed according to a heuristics switching model that has performed well in earlier work. We show how the economy behaves under these assumptions with a special focus on inflation volatility. Contrary to comparable models based on full rationality, the behavioral model predicts that inflation volatility can be lowered if the central bank reacts to the output gap in addition to inflation. We test the opposing theoretical predictions with a learning to forecast experiment. The experimental results support the behavioral model and the claim that reacting to the output gap in addition to inflation can indeed lower inflation volatility.
The Journal of Socio-Economics, 2013
In this paper we study how in ‡ation expectations are formed and whether these change due to the occurrence of policy shifts or structural breaks. We conduct 4 experiments with 75 inexperienced subjects, in which we ask them to predict future home in ‡ation and report con…dence intervals. At three points in time during our experiments, we also ask our participants to provide additional information regarding the uncertainty about their expectations. Our design allowed us to gather 6750 home in ‡ation point forecasts and con…dence intervals. We …nd that: (1) in ‡ation expectations are seldom rational; (2) our subjects generally ignore valuable information and, instead, tend to pay close attention to past trends; (3) the adoption of in ‡ation targeting increases the amount of subjects that forecast in a rational fashion and reduces the uncertainty about future in ‡ation; and (4) a recession reduces rationality among forecasters, yet induces them to expect in ‡ation to revert to its mean.
Expectation, learning, and the costs of disinflation.pdf
The macroeconomic costs of disinflation are considered for the United States in a rational expectations macroeconometric model with sticky prices and imperfect information regarding monetary policy objectives. The analysis centers on simulation experiments using the Board's new quarterly macroeconometric model, FRB/US, within which are nested both expectations formation that is 'rational' (i.e., model consistent) and 'restricted-information rational' (i.e., where the information set is restricted to that captured by a small-scale VAR model). We characterize monetary policy as being governed by rules. Disinflations are represented by changes in the target inflation rate of a interest-rate reaction function. Two kinds of rules are considered: a version of the Taylor rule and the other being a more aggressive and richer specification estimated using data for the last 15 years. We assume agents are not fully cognizant of changes in the Fed's inflation target and must instead adjust their perceptions of the target according to a linear updating rule. Simulation results for sacrifice ratios are compared with results from other models and with econometric results and calculations reported in the literature.
Macroeconomic Dynamics, 2020
Drawing on a considerable empirical literature that reveals persistent and endogenously time-varying heterogeneity in inflation expectations, this paper embeds two inflation forecasting strategiesone based on costly ex ante full rationality or perfect foresight, and the second based on costless ex ante bounded rationality or extrapolative trend-followingin a dynamic macroeconomic model. Drawing also on the significant empirical evidence that inflation forecast errors may have to exceed some threshold before agents abandon their previously selected inflation forecasting strategy, we describe agents as switching between inflation forecasting strategies according to evolutionarily satisficing learning dynamics. We find that convergence to a long-run equilibrium consistent with growth, unemployment and inflation at their natural levels may be achieved even when heterogeneity in inflation expectations (with predominance of the extrapolative trend-following foresight strategy) is an attractor of an evolutionarily satisficing learning dynamic perturbed by mutant agents. Therefore, in keeping with robust empirical evidence, heterogeneity in strategies to form inflation expectations (with prevalence of boundedly rational expectations) can be a stable long-run equilibrium.