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Heterogeneous inflation expectations, learning, and market outcomes

  • Carlos Madeira
  • Basit Zafar

Using the panel component of the Michigan Survey of Consumers, we show that individuals, in particular women and ethnic minorities, are highly heterogeneous in their expectations of inflation. We estimate a model of inflation expectations based on learning from experience that also allows for heterogeneity in both private information and updating. Our model vastly outperforms existing models of inflation expectations in explaining the heterogeneity in the data. We find that women, ethnic minorities, and less educated agents have a higher degree of heterogeneity in their private information, and are also slower to update their expectations. In addition, we show that personal income forecasts are positively related to subjective inflation expectations. During the 2000s, consumers believe inflation to be more persistent in the short term, but temporary fluctuations in inflation have less effect on income and long-term inflation expectations. Finally, we find evidence that sticky expectations and the heterogeneity of new information received by consumers generate higher mark-ups and inflation.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 536.

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Date of creation: 2012
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Handle: RePEc:fip:fednsr:536
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  1. William A. Branch, 2004. "The Theory of Rationally Heterogeneous Expectations: Evidence from Survey Data on Inflation Expectations," Economic Journal, Royal Economic Society, vol. 114(497), pages 592-621, 07.
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  13. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," Harvard Institute of Economic Research Working Papers 1922, Harvard - Institute of Economic Research.
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  15. Robert Rich & Joseph Tracy, 2006. "The relationship between expected inflation, disagreement, and uncertainty: evidence from matched point and density forecasts," Staff Reports 253, Federal Reserve Bank of New York.
  16. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  17. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, June.
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