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Disagreement and Biases in Inflation Expectations

  • Carlos Capistrán
  • Allan Timmermann

    ()

    (School of Economics and Management, University of Aarhus, Denmark and CREATES)

Disagreement in inflation expectations observed from survey data varies systematically over time in a way that reflects the level and variance of current inflation. This paper offers a simple explanation for these facts based on asymmetries in the forecasters’ costs of over- and under-predicting inflation. Our model implies (i) biased forecasts; (ii) positive serial correlation in forecast errors; (iii) a cross-sectional dispersion that rises with the level and the variance of the inflation rate; and (iv) predictability of forecast errors at different horizons by means of the spread between the short- and long-term variance of inflation. We find empirically that these patterns are present in inflation forecasts from the Survey of Professional Forecasters. A constant bias component, not explained by asymmetric loss and rational expectations, is required to explain the shift in the sign of the bias observed for a substantial portion of forecasters around 1982.

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Paper provided by Department of Economics and Business Economics, Aarhus University in its series CREATES Research Papers with number 2008-56.

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Length: 53
Date of creation: 19 Sep 2008
Date of revision:
Handle: RePEc:aah:create:2008-56
Contact details of provider: Web page: http://www.econ.au.dk/afn/

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