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  5. Biases in Expectation Formation: Evidence and Mechanisms
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Biases in Expectation Formation: Evidence and Mechanisms

Paper Session

Friday, Jan. 3, 2025 10:15 AM - 12:15 PM (PST)

Hilton San Francisco Union Square, Yosemite A
Hosted By: American Economic Association
  • Chair: Dmitry Taubinsky, University of California-Berkeley

Information and Subjective Expectations: Global Evidence

Francesco D'Acunto
,
Georgetown University
Michael Weber
,
University of Chicago

Abstract

Using novel data covering about 50,000 consumers across 47 countries representing 90% of global GDP, we find substantial heterogeneity in the sources of information consumers use to form their subjective macroeconomic expectations both within and across countries. Consumers who use signals from their local economic environments form higher inflation, interest rate, and house price expectations relative to consumers who use the signals about the aggregate economy provided in official reports and traditional media. Consistent with rational inattention, consumers in countries with higher historical inflation are more likely to obtain economic information but predominantly so from their local economic environments, which leads to higher perception errors about current realizations and biased macroeconomic expectations. Trust in governments and central banks increases exposure to aggregate economic signals thus lowering perception errors and expectations. Heterogeneity in the sources of information consumers use to obtain signals about the economy is important to understand known biases in the cross-section of subjective macroeconomic expectations and stresses the role of communication as a policy tool for central banks and governments worldwide.

What Explains the Gap Between Consumption and Financial Plans and Actions? The Role of Inflation Literacy, Shocks, and Changes in Expectations and Objectives

Marieke Bos
,
Vrije Universiteit Amsterdam
Arna Olafsson
,
Copenhagen Business School
Enrichetta Ravina
,
Federal Reserve Bank of Chicago
Basit Zafar
,
University of Michigan

Abstract

Abstract: Leveraging a large two-wave survey of Icelandic bank customers linked to detailed and comprehensive administrative bank data, we study households’ knowledge of inflation, their understanding of its mechanisms and effects, and how they plan to adjust their expenditures, borrowing, and financial investments to protect themselves from future expected and unexpected inflation. We administer short explanations on various aspects of how inflation works to random subsets of households and test their understanding thereof. We then compare households’ recollections, plans, and understanding of inflation with their expenditure, borrowing, and investment behavior, both before and after administering the explanations. Next we investigate the discrepancies between households’ plans about future expenditures, borrowing, and financial investments and their real actions. Finally, we survey them about the considerations made when making those decisions as well as what roles economic shocks, changes in expectations or objectives, inertia, and other factors played in explaining the discrepancies between their plans and actions.

How Inflation Expectations Dis-Anchor: the Role of Selective Memory Cues

Nicola Gennaioli
,
Bocconi University
Marta Leva
,
Bocconi University
Raphael Schoenle
,
Brandeis University
Andrei Shleifer
,
Harvard

Abstract

This paper highlights the central role of cued recall for understanding the formation of inflation
expectations. We present a memory model of belief formation about inflation, which predicts sharp belief instability due to selective, similarity-based, recall of past inflation experiences. We test the model’s prediction using individual-level inflation expectations from the New York Fed’s Survey of Consumer Expectations and the University of Michigan’s Consumer Survey. The model can explain how expectations quickly became unanchored during the recent post-pandemic rise in inflation, and how expectations of the elderly rose faster and more sharply than those of the young. It also makes novel predictions for how people estimate and allocate weights to future inflation ranges, which also turn out to be consistent with the data.

Beliefs About the Economy are Excessively Sensitive to Household-Level Shocks: Evidence from Linked Survey and Administrative Data

Luigi Butera
,
Copenhagen Business School
Chen Lian
,
University of California-Berkeley
Matteo Saccarola
,
University of California-Berkeley
Dmitry Taubinsky
,
University of California-Berkeley

Abstract

We study how people's beliefs about the economy covary with household-level events, utilizing a unique link between Danish administrative data and a large-scale survey of consumer expectations. We find that compared to actual inflation, people's inflation forecasts covary much more strongly (and negatively) with both recently realized household income changes and measures of expected future household income changes. We formally establish that these findings are stark deviations from the Bayesian limited-information rational expectations (LIRE) benchmark. Similar results hold for perceptions of past inflation (“backcasts”), suggesting that imperfect recall is a key mechanism for biased forecasts. Building on this, a series of additional tests, some of which utilize data on adverse health events, suggests that the forecast biases are at least partly due to selective recall cued by affective associations. That is, negative (positive) household-level events cue negative (positive) recollections, which lead to pessimistic (optimistic) forecasts.
JEL Classifications
  • E7 - Macro-Based Behavioral Economics
  • D9 - Micro-Based Behavioral Economics