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Disagreement and Biases in Inflation Expectations

  • Carlos Capistrán
  • Allan Timmermann

Recent empirical work documents substantial disagreement in inflation expectations obtained from survey data. Furthermore, the extent of such disagreement 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 forecaster's costs of over- and under-predicting inflation. Our model implies biased forecasts with positive serial correlation in forecast errors and a cross-sectional dispersion that rises with the level and the variance of the inflation rate. It also implies that biases in forecaster's ranks should be preserved over time and that forecast errors at different horizons can be predicted through 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.

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Paper provided by Banco de México in its series Working Papers with number 2006-07.

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Date of creation: Jun 2006
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Handle: RePEc:bdm:wpaper:2006-07
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