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The Formation of Expectations and Macroeconomic Dynamics

Paper Session

Sunday, Jan. 7, 2018 1:00 PM - 3:00 PM

Marriott Philadelphia Downtown, Grand Ballroom Salon L
Hosted By: American Economic Association
  • Chair: Olivier Coibion, University of Texas-Austin

Expectation Formation Following Large Unexpected Shocks

Scott Baker
,
Northwestern University
Tucker McElroy
,
U.S. Census Bureau
Xuguang Sheng
,
American University

Abstract

By matching a large database of individual forecaster data with the universe of natural disasters across 54 countries, we identify a set of new stylized facts: (i) forecasters are persistently heterogeneous in how often they issue or revise a forecast; (ii) information rigidity declines significantly following large, unexpected natural disaster shocks across many countries and variables; (iii) the response of forecast disagreement displays interesting patterns: attentive forecasters tend to move away from the previous consensus following a disaster while the opposite is true for inattentive forecasters. We develop a learning model that captures the two channels through which natural disaster shocks affect expectation formation: attention effect - the visibly large shocks induce immediate and synchronized updating of information for inattentive agents, and uncertainty effect - the occurrence of those shocks generates increased uncertainty among attentive agents.

Dynamic Inattention, the Phillips Curve, and Forward Guidance

Hassan Afrouzi
,
University of Texas-Austin
Choongryul Yang
,
University of Texas-Austin

Abstract

We 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

Carlos Carvalho
,
Pontifical Catholic University of Rio de Janeiro
Stefano Eusepi
,
Federal Reserve Bank of New York
Emanuel Moench
,
Deutsche Bundesbank
Bruce Preston
,
University of Melbourne

Abstract

According 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

Olivier Coibion
,
University of Texas-Austin
Yuriy Gorodnichenko
,
University of California-Berkeley
Saten Kumar
,
Auckland University of Technology
Jane Ryngaert
,
University of Texas-Austin

Abstract

Using 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.
Discussant(s)
Philippe Andrade
,
Bank of France
Eric Sims
,
University of Notre Dame
Eric Swanson
,
University of California-Irvine
Jennifer La'O
,
Columbia University
JEL Classifications
  • E3 - Prices, Business Fluctuations, and Cycles
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit