Heterogeneous Inflation Expectations Across Economic Agents: Implications for Monetary Policy

It is well-documented in economic literature that inflation expectations exhibit significant heterogeneity across various economic agents, notably households, firms, and financial institutions. This paper investigates the relative importance of these agents' expectations in shaping inflation dynamics within a general equilibrium framework. We introduce non-rational, non-systematic expectation shocks into an otherwise standard small open economy New-Keynesian model, calibrated and estimated using Russian data. This novel approach allows us to isolate exogenous variations in inflation expectations specific to each agent type and assess their distinct impacts on realized inflation. Our results demonstrate that central banks must respond explicitly to non-rational, non-systematic expectation shocks originating from private agents. Importantly, we find that expectation shocks from financial institutions (banks) exert a larger influence on realized inflation than shocks originating from households or firms. This outcome remains robust across multiple variations in model structure and parameterization. In contrast, the inflationary effects of households’ and firms’ expectation shocks manifest in ways unpredictable to these agents themselves, highlighting an expectations-feedback gap. The findings have important implications for monetary policy, particularly regarding communication strategies.