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Asymmetric Inflation Expectations, Downward Rigidity of Wages, and Asymmetric Business Cycles

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  • Baqaee, David Rezza

Abstract

This paper shows that household expectations of the inflation rate are more responsive to inflationary news than to disinflationary news. This asymmetry in inflation expectations can be a source of downward nominal wage rigidity, since workers expectations adjust more quickly to inflationary shocks than disinflationary shocks. I embed asymmetric beliefs into a general equilibrium model and show that, in such a model, monetary policy has asymmetric effects on employment, output, and wage inflation consistent with the data. I microfound asymmetric household expectations using ambiguity-aversion: households, who do not know the quality of their information, overweight inflationary news since it reduces their purchasing power, and underweight deflationary news since it increases their purchasing power. Although wages are downwardly rigid in this environment, monetary policy need not have a bias towards using inflation to grease the wheels of the labor market.

Suggested Citation

  • Baqaee, David Rezza, 2018. "Asymmetric Inflation Expectations, Downward Rigidity of Wages, and Asymmetric Business Cycles," CEPR Discussion Papers 12906, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:12906
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    Cited by:

    1. Marmora, Paul, 2022. "Does monetary policy fuel bitcoin demand? Event-study evidence from emerging markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 77(C).
    2. David O. Cushman & Glauco De Vita & Emmanouil Trachanas, 2023. "Is the Fisher effect asymmetric? Cointegration analysis and expectations measurement," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(4), pages 3727-3748, October.
    3. Yuriy Gorodnichenko & Dmitriy Sergeyev, 2021. "Zero Lower Bound on Inflation Expectations," NBER Working Papers 29496, National Bureau of Economic Research, Inc.
    4. khan, sajawal, 2018. "Managing the Expectations and Monetary Policy effectiveness: Role of Inflation Targeting," MPRA Paper 93170, University Library of Munich, Germany, revised 20 Feb 2019.
    5. Dmitri V. Vinogradov & Michael J. Lamla & Yousef Makhlouf, 2024. "Survey-based expectations and uncertainty attitudes," Working Papers 2024_02, Business School - Economics, University of Glasgow.
    6. Cosmin L. Ilut & Martin Schneider, 2022. "Modeling Uncertainty as Ambiguity: a Review," NBER Working Papers 29915, National Bureau of Economic Research, Inc.
    7. repec:ecb:ecbdps:202424 is not listed on IDEAS
    8. Riccardo M Masolo & Francesca Monti, 2021. "Ambiguity, Monetary Policy and Trend Inflation," Journal of the European Economic Association, European Economic Association, vol. 19(2), pages 839-871.
    9. Coleman, Winnie & Nautz, Dieter, 2025. "Asymmetric inflation target credibility," Discussion Papers 2025/1, Free University Berlin, School of Business & Economics.
    10. Yoo, Donghoon, 2019. "Ambiguous information, permanent income, and consumption fluctuations," European Economic Review, Elsevier, vol. 119(C), pages 79-96.
    11. Gabriel Chodorow-Reich & Johannes Wieland, 2020. "Secular Labor Reallocation and Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 128(6), pages 2245-2287.
    12. Yongheng Hu, 2025. "How Big Data Dilutes Cognitive Resources, Interferes with Rational Decision-making and Affects Wealth Distribution ?," Papers 2508.20435, arXiv.org, revised Aug 2025.
    13. Nagel, Stefan & Yan, Zhen, 2022. "Inflation Hedging on Main Street? Evidence from Retail TIPS Fund Flows," CEPR Discussion Papers 17695, C.E.P.R. Discussion Papers.
    14. Coleman, Winnie & Nautz, Dieter, 2025. "Asymmetric inflation target credibility," Journal of International Money and Finance, Elsevier, vol. 157(C).
    15. Maenhout, Pascal J. & Vedolin, Andrea & Xing, Hao, 2025. "Robustness and dynamic sentiment," Journal of Financial Economics, Elsevier, vol. 163(C).
    16. Donayre, Luiggi, 2022. "On the behavior of Okun's law across business cycles," Economic Modelling, Elsevier, vol. 112(C).
    17. Tura-Gawron, Karolina, 2019. "Consumers’ approach to the credibility of the inflation forecasts published by central banks: A new methodological solution," Journal of Macroeconomics, Elsevier, vol. 62(C).
    18. Tsai, I-Chun, 2020. "Alternative explanation of the money illusion: The effect of unexpected low inflation," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 110-123.
    19. Chen, Heng & Li, Xu & Pei, Guangyu & Xin, Qian, 2024. "Heterogeneous overreaction in expectation formation: Evidence and theory," Journal of Economic Theory, Elsevier, vol. 218(C).
    20. Metiu, Norbert & Prieto, Esteban, 2023. "The macroeconomic effects of inflation uncertainty," Discussion Papers 32/2023, Deutsche Bundesbank.
    21. Sias, Richard & Starks, Laura T. & Turtle, H.J., 2023. "The negativity bias and perceived return distributions: Evidence from a pandemic," Journal of Financial Economics, Elsevier, vol. 147(3), pages 627-657.
    22. Winnie Coleman & Dieter Nautz, 2025. "Asymmetric Inflation Target Credibility," Berlin School of Economics Discussion Papers 0060, Berlin School of Economics.
    23. Gobbi, Lucio & Mazzocchi, Ronny & Tamborini, Roberto, 2025. "Inflation shocks and the New Keynesian model: When should central banks fear inflation expectations?," The North American Journal of Economics and Finance, Elsevier, vol. 80(C).
    24. Karolina Tura-Gawron & Maria Siranova & Karol Fisikowski, 2018. "ARE CONSUMER INFLATION EXPECTATIONS AN INTERNATIONAL PHENOMENON? Results of spatial panel regressions models," GUT FME Working Paper Series A 50, Faculty of Management and Economics, Gdansk University of Technology.
    25. Coleman, Winnie & Nautz, Dieter, 2025. "Asymmetric inflation target credibility," CFS Working Paper Series 731, Center for Financial Studies (CFS).

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    JEL classification:

    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications

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