The Formation of Expectations and Macroeconomic Dynamics
Sunday, Jan. 7, 2018 1:00 PM - 3:00 PM
- Chair: Olivier Coibion, University of Texas-Austin
Dynamic Inattention, the Phillips Curve, and Forward Guidance
AbstractWe show that rationally inattentive firms are forward-looking in their information acquisition and study the implications of these incentives for inflation dynamics by deriving a new microfounded Phillips curve. The Phillips curve is forward looking and relates current inflation to the forecast errors of firms about future inflation and the growth rate of the output gap in the economy -- a feature that is absent in sticky and noisy information models. Unlike the forward-looking Phillips curves derived under nominal rigidities, we show inflation is not necessarily increasing in expected inflation, and it decreases with the forecast errors of firms about future inflation and output gap growth. We test this Phillips curve using the Survey of Professional Forecasters as a proxy for firms’ expectations and show that forecast errors about future significantly affect current inflation in the direction that is predicted by the model. We apply our findings to examine the effectiveness of forward guidance policies in a general equilibrium model. News about future interest rates affects inflation more if firms are more rationally inattentive or if they discount future profits less. The model also survives the forward guidance puzzle as the initial response of inflation decreases with the horizon of forward guidance.
Anchored Inflation Expectations
AbstractAccording to both central bankers and economic theory, anchored inflation expectations are key to successful monetary policymaking. Yet, we know very little about the determinants of those expectations. While policymakers may take some comfort in the stability of long-run inflation expectations, the latter is not an inherent feature of the economy. What does it take for expectations to become unanchored? We explore a theory of expectations formation that can produce episodes of unanchoring. Its key feature is state-dependency in the sensitivity of long-run inflation expectations to short-run inflation surprises. Price-setting agents act as econometricians trying to learn about average long-run inflation. They set prices according to their views about future inflation, which hence feed back into actual inflation. When expectations are anchored, agents believe there is a constant long-run inflation rate, which they try to learn about. Hence, their estimates of long-run inflation move slowly, as they keep adding observations to the sample they consider. However, in the spirit of Marcet and Nicolini (2003), a long enough sequence of inflation surprises leads agents to doubt the constancy of long-run inflation, and switch to putting more weight on recent developments. As a result, long-run inflation expectations become unanchored, and start to react more strongly to short-run inflation surprises. Shifts in agents' views about long-run inflation feed into their price-setting decisions, imparting a drift to actual inflation. Hence, actual inflation can show persistent swings away from its long-run mean. We estimate the model using actual inflation data, and only short-run inflation forecasts from surveys. The estimated model produces long-run forecasts that track survey measures extremely well.
Do You Know That I Know You Know…? Higher Order Beliefs in Survey Data
AbstractUsing novel survey questions on higher-order expectations of firm managers, we study the formation and evolution of these beliefs. An experimental approach allows us to characterize the degree of higher-order thinking of economic agents and how this relates to characteristics of both the individuals as well as the firms for which they work. We then relate these results to macroeconomic models in which higher-order thinking matters for dynamics.
Bank of France
University of Notre Dame
University of California-Irvine
- E3 - Prices, Business Fluctuations, and Cycles
- E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit