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  5. Expectations and the Macro Economy
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Expectations and the Macro Economy

Paper Session

Friday, Jan. 6, 2023 2:30 PM - 4:30 PM (CST)

Hilton Riverside, Grand Salon B Sec 10
Hosted By: American Economic Association
  • Chair: Jonathan Adams, University of Florida

Business Cycles when Consumers Learn by Shopping

Angelo Gutierrez-Daza
,
Banco de México

Abstract

Consumers rely on their shopping experiences to form beliefs about inflation. In other words,
they "learn by shopping". I study the consequences of this information friction for the transmission of
macroeconomic shocks. I introduce learning by shopping in the benchmark New Keynesian model
and show that this friction anchors households’ beliefs about inflation. However, the degree of
anchoring is endogenous and depends on the model’s structural features, including the monetary
policy stance. Learning by shopping propagates the impact of demand shocks on output, even
when prices are flexible. Price stickiness exacerbates this propagation, and the interaction of both
frictions can be larger than the sum of the effects of each friction considered separately. Moreover,
learning by shopping makes the slope of the Phillips curve a function of the degree of anchoring.
For this reason, a more hawkish monetary policy can simultaneously anchor households’ inflation
expectations, flatten the Phillips curve, and lower the volatility and persistence of inflation. The
model suggests that such a policy also has an unintended consequence: It makes the economy
more vulnerable to exogenous shifts in aggregate demand.

Consumer Memory, Inflation Expectations and the Interpretation of Shocks

Gabriel Zuellig
,
University of Oxford

Abstract

I study the role of consumers' memories of business cycles when they interpret new macroeconomic data to make a forecast of inflation. Individuals who recall co-moving inflation and unemployment from experience are more apt to adjust their inflation expectations in line with supply shocks. I use 40 years of survey data to disentangle age and cohort effects from individuals' experience of business cycles. The channel is illustrated using the age profile in changes of inflation expectations during the first wave of the Covid-19 pandemic, which bears elements of both demand- and supply-side shocks. Those cohorts who have experienced more supply shocks increase their inflation expectations more, even conditional on the personal financial situation or differences in consumption baskets. They also devote less attention to
demand-side channels and are more likely to have heard news about restricted supply. Previous supply shock exposure increases the attention to central bank news and the real effects of monetary policy.

A Comprehensive Empirical Evaluation of Biases in Expectation Formation

Kenneth Eva
,
Federal Reserve Board
Fabian Winkler
,
Federal Reserve Board

Abstract

We revisit the evidence on predictability of forecast errors in macroeconomic survey data, which is sometimes taken as evidence of behavioral biases at odds with rational expectations. We argue that to reject rational expectations, one must be able to predict forecast errors out of sample. However, the regressions used in the literature perform poorly out of sample in most cases. The models seem unstable and could not have helped to improve forecasts with access only to available information. However, we do find some notable exceptions, such as mean bias in interest rate forecasts, that survive our out-of-sample tests. Our findings thus narrow down the set of biases that merit the attention of researchers in behavioral macroeconomics.

Human Frictions in the Transmission of Economic Policies

Francesco D'Acunto
,
Georgetown University
Daniel Hoang
,
Karlsruhe Institute of Technology
Maritta Paloviita
,
Bank of Finland
Michael Weber
,
University of Chicago

Abstract

Many consumers below the top of the distribution of a representative population by cognitive abilities barely react to monetary and fiscal policies that aim to stimulate consumption and borrowing, even when they are financially unconstrained and despite substantial debt capacity. Differences in income, formal education levels, economic expectations, and a large set of registry-based demographics do not explain these facts. Heterogeneous cognitive abilities thus act as \textit{human frictions} in the transmission of economic policies that operate through the household sector and might imply redistribution from low- to high-cognitive-ability agents. We conclude by discussing how our findings inform the microfoundation of behavioral macroeconomic theory.

Expectations and Credit Slumps

Jasmine Xiao
,
University of Notre Dame
Antonio Falato
,
Federal Reserve Board

Abstract

Since the 2008-09 financial crisis, U.S. bank lending has been slow to recover, despite the period of very low interest rates. We show that banks do not process information efficiently, and this is a quantitatively important explanation for credit slumps after 2008. Using a new dataset of bank expectations, we find that banks over-extrapolate the past, and their lending decisions are sensitive to beliefs. The behavioral bias is stronger for large banks, whose loan portfolios are also more sensitive to beliefs. To quantify the economic significance of imperfect expectations, we build a dynamic model with heterogeneous banks that are over-extrapolative and face a small risk of economic disaster. We show that a realistic degree of over-extrapolation estimated from the data generates the pace of credit and real recovery observed after the crisis. Banks' distorted beliefs hamper the effectiveness of policy tools, such as quantitative easing (QE) programs.

Expected Inflation and Welfare: The Role of Consumer Search

Francisca Sara-Zaror
,
Federal Reserve Board

Abstract

In standard macroeconomic models, the costs of inflation are tightly linked to the price dispersion of identical goods. Therefore, understanding how price dispersion empirically relates to inflation is crucial for welfare analysis. In this paper, I study the relationship between steady-state inflation and price dispersion for a cross section of U.S. retail products using scanner data. By comparing prices of items with the same barcode, my measure of relative price dispersion controls for product heterogeneity, overcoming an important challenge in the literature. I document a new fact: price dispersion of identical goods increases steeply around zero inflation and becomes flatter as inflation increases, displaying an Upsilon-shaped pattern. Current sticky-price models are inconsistent with this finding. I develop a menu-cost model with idiosyncratic productivity shocks and sequential consumer search that reproduces the new fact and exhibits realistic price-setting behavior. In the model, inflation-induced price dispersion increases shoppers' incentives to search for low prices and thus competition among retailers. The positive welfare-maximizing inflation rate optimally trades off the efficiency gains from lower markups and the resources spent on search.
JEL Classifications
  • E7 - Macro-Based Behavioral Economics