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Testing Near-Rationality using Detailed Survey Data

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  • Bryan, Michael F.

    ()
    (Federal Reserve Bank of Cleveland)

  • Palmqvist, Stefan

    ()
    (Monetary Policy Department, Central Bank of Sweden)

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    Abstract

    This paper considers the evidence of “near-rationality,” as described by Akerlof, Dickens, and Perry (2000). Using detailed surveys of household inflation expectations for the United States and Sweden, we find that the data are generally unsupportive of the near-rationality hypothesis. However, we document that household inflation expectations tend to settle around discrete and largely fixed “focal points,” suggesting that both U.S. and Swedish households gauge inflation prospects in rather broad, qualitative terms. Moreover, the combination of a low-inflation environment and an inflation target in Sweden has been accompanied by a disproportionately high proportion of Swedish households expecting no inflation. However, a similar low-inflation trend in the United States, which does not have an explicit inflation target, reveals no such rise in the proportion of households expecting no inflation. This observation suggests that the way the central bank communicates its inflation objective may influence inflation expectations independently of the inflation trend it actually pursues.

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    Bibliographic Info

    Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 183.

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    Length: 40 pages
    Date of creation: 01 Apr 2005
    Date of revision:
    Handle: RePEc:hhs:rbnkwp:0183

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    Keywords: inflation expectations; rationality; inflation targeting; Phillips curve;

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    References

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    1. N. Gregory Mankiw & Ricardo Reis & Justin Wolfers, 2004. "Disagreement about Inflation Expectations," NBER Chapters, in: NBER Macroeconomics Annual 2003, Volume 18, pages 209-270 National Bureau of Economic Research, Inc.
    2. Lundborg, Per & Sacklén, Hans, 2003. "Low-Inflation Targeting and Unemployment Persistence," Working Paper Series 188, Trade Union Institute for Economic Research.
    3. Christopher D Carroll, 2001. "The Epidemiology of Macroeconomic Expectations," Economics Working Paper Archive 462, The Johns Hopkins University,Department of Economics.
    4. Jonung, Lars, 1981. "Perceived and Expected Rates of Inflation in Sweden," American Economic Review, American Economic Association, vol. 71(5), pages 961-68, December.
    5. Keane, Michael P & Runkle, David E, 1990. "Testing the Rationality of Price Forecasts: New Evidence from Panel Data," American Economic Review, American Economic Association, vol. 80(4), pages 714-35, September.
    6. Michael F. Bryan & Guhan Venkatu, 2001. "The curiously different inflation perspectives of men and women," Economic Commentary, Federal Reserve Bank of Cleveland, issue Nov.
    7. Figlewski, Stephen & Wachtel, Paul, 1981. "The Formation of Inflationary Expectations," The Review of Economics and Statistics, MIT Press, vol. 63(1), pages 1-10, February.
    8. Kenneth N Kuttner, 2004. "A Snapshot of Inflation Targeting in its Adolescence," RBA Annual Conference Volume, in: Christopher Kent & Simon Guttmann (ed.), The Future of Inflation Targeting Reserve Bank of Australia.
    9. Jushan Bai & Pierre Perron, 1998. "Estimating and Testing Linear Models with Multiple Structural Changes," Econometrica, Econometric Society, vol. 66(1), pages 47-78, January.
    10. George A. Akerlof & William T. Dickens & George L. Perry, 2000. "Near-Rational Wage and Price Setting and the Long-Run Phillips Curve," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(1), pages 1-60.
    11. Yash P. Mehra, 2002. "Survey measures of expected inflation : revisiting the issues of predictive content and rationality," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 17-36.
    12. Lundborg, Per & Sacklén, Hans, 2001. "Is There a Long Run Unemployment-Inflation Trade-off in Sweden?," Working Paper Series 173, Trade Union Institute for Economic Research.
    13. Souleles, Nicholas S, 2004. "Expectations, Heterogeneous Forecast Errors, and Consumption: Micro Evidence from the Michigan Consumer Sentiment Surveys," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(1), pages 39-72, February.
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