Ina Hajdini

This paper shows that regime shifts in Full-Information Rational Expectations (FIRE) models generate predictable regime-dependent forecast errors in macro aggregates. Hence, forecast error predictability alone is neither sufficient to reject FIRE nor informative about alternative expectations theories. We instead propose a regime-robust test of FIRE and apply it to a medium-scale New Keynesian model with monetary policy regime shifts that is estimated on US data. While the test fails to decisively reject FIRE, the model conditional on macro data implies expectations that are generally different from observed survey forecasts, thus providing a new empirical motivation for alternative expectations theories.

Based on a framework of memory and recall that accounts for social networks, we provide conditions under which social networks can amplify expectations. We provide evidence for several predictions of the model using a novel dataset on inflation expectations and social network connections: Inflation expectations in the social network are statistically significantly, positively associated with individual inflation expectations; the relationship is stronger for groups that share common demographic characteristics, such as gender, income, or political affiliation. An instrumental variable approach further establishes causality of these results while also showing that salient information transmits strongly through the network. Our estimates imply that the influence of the social network overall amplifies but does not destabilize inflation expectations.

We implement a novel methodology to disentangle two-way causality in inflation and income expectations in a large, nationally representative survey of US consumers. We find a 20 percent passthrough from expected inflation to expected income growth, but no statistically significant effect in the other direction. Passthrough is higher for higher-income individuals and men. Higher inflation expectations increase consumers’ likelihood to search for higher-paying new jobs. In a calibrated search-and-matching model, dampened responses of wages to demand and supply shocks translate into greater output fluctuations. The survey results and model analysis provide a labor market channel for why people dislike inflation.

The paper considers a New Keynesian framework in which agents form expectations based on a combination of autoregressive mis-specified forecasts and myopia. The proposed expectations formation process is shown to be consistent with all three empirical facts on consensus inflation forecasts. However, while mis-specified forecasts can be both sufficient and necessary to match all three facts, myopia alone is neither. The paper then derives the general equilibrium solution consistent with the proposed expectations formation process and estimates the model with likelihood-based Bayesian methods, yielding three novel results: (i) macroeconomic data strongly prefer a combination of autoregressive mis-specified forecasting rules - of the VAR(1) or AR(1) type - and myopia over other alternatives; (ii) no strong evidence is found in favor of VAR(1) forecasts over simple AR(1) rules; and (iii) frictions such as habit in consumption, which are typically necessary for models with full-information rational expectations, are significantly less important, because the proposed expectations generate substantial internal persistence and amplification to exogenous shocks. Simulated inflation expectations data from the estimated general equilibrium model reflect the three empirical facts on forecasting data.

Based on indirect utility theory, we introduce a novel methodology of measuring inflation expectations indirectly. This methodology starts at the individual level, asking consumers about the change in income required to buy the same amounts of goods and services one year ahead. Analytically, our methodology possesses smaller ex-post aggregate inflation forecast errors relative to forecasts based on conventional survey questions. We ask this question in a large-scale, high-frequency survey of consumers in the US and 14 countries, and we show that indirect consumer inflation expectations perform well along several empirical dimensions. Exploiting the geographically detailed, high-frequency variation in the data, we then show that individual experiences matter for inflation expectations, in a nuanced way. For example, age and gender have different effects internationally, while individual inflation and local experiences are generally highly relevant. In an application to gasoline price changes, we identify large effects of experienced gasoline price changes on inflation expectations, characterized by both overreaction and persistence.

Using a novel experimental setup, we study the direction of causality between consumers’ inflation expectations and their income growth expectations. In a large, nationally representative survey of US consumers, we find that the rate of passthrough from expected inflation to expected income growth is incomplete, on the order of 20 percent. There is no statistically significant effect going in the other direction. Passthrough varies systematically with demographic and socioeconomic factors, with greater passthrough for higher-income individuals than lower-income individuals, although it is still incomplete. Higher inflation expectations also cause consumers to report a higher probability that they will search for a new job that pays more. Using our survey findings to calibrate a search-and-matching model, we find that dampened responses of real wages to demand and supply shocks translate into greater fluctuations in output. Taken together, the survey results and model exercises provide a labor market channel to explain why people dislike inflation.

The paper considers a New Keynesian framework in which agents form expectations based on a combination of mis-specified forecasts and myopia. The proposed expectations formation process is found to be consistent with all three empirical facts on consensus inflation forecasts, namely, that forecasters under-react to ex-ante forecast revisions, that forecasters over-react to recent events, and that the response of forecast errors to a shock initially under-shoots but then over-shoots. The paper then derives the general equilibrium solution consistent with the proposed expectations formation process and estimates the model with likelihood-based Bayesian methods, yielding three novel results.

By introducing Jaimovich-Rebelo (JR) consumption-labor nonseparable preferences into an otherwise standard New Keynesian model, we show that the occurrence of positive comovement between inflation and the nominal interest rate conditional on a nominal shock - the so-called neo-Fisherian hypothesis - depends on the extent of wealth effects in households’ labor supply decisions. Neo-Fisherianism appears more prominent in economic environments with i) weaker wealth effects on labor supply (in particular for Greenwood-Hercowitz-Huffmann preferences where wealth effects are absent), and ii) smaller price-to-wage markups (for which the steady state is less distorted). The stabilizing properties of Taylor rules under JR preferences are scrutinized.

Large declines in bank equity price indices are generally followed by declines in credit supply and economic activity, but they do not affect inflation.

Trend inflation has risen notably since 2021, leading to a higher Phillips curve slope and stronger link between inflation and inflation expectations.

Surveys often measure consumers’ inflation expectations by asking directly about prices in general or overall inflation, concepts that may not be well-defined for some individuals. In this Commentary, we propose a new, indirect way of measuring consumer inflation expectations: Given consumers’ expectations about developments in prices of goods and services during the next 12 months, we ask them how their incomes would have to change to make them equally well-off relative to their current situation such that they could buy the same amount of goods and services as they can today. Using a massive number of survey responses at a high frequency, we show that this measure of indirect consumer inflation expectations has risen sharply since early 2021. Higher inflation experiences correlate with higher indirect consumer inflation expectations across US cities and around the world.