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Are Consumer Expectations Theory-Consistent? The Role of Macroeconomic Determinants and Central Bank Communication

Using the microdata of the Michigan Survey of Consumers, we evaluate whether U.S. consumers form macroeconomic expectations consistent with different economic concepts. We check whether their expectations are in line with the Phillips Curve, the Taylor Rule and the Income Fisher Equation. We observe that 50% of the surveyed population have expectations consistent with the Income Fisher equation and the Taylor Rule, while 25% are in line with the Phillips Curve. However, only 6% of consumers form theory-consistent expectations with respect to all three concepts. For the Taylor Rule and the Phillips curve we observe a strong cyclical pattern. For all three concepts we find significant differences across demographic groups. Evaluating determinants of consistency, we provide evidence that the likelihood of having theory-consistent expectations with respect to the Phillips curve and the Taylor rule falls during recessions and with inflation higher than 2%. Moreover, consistency with respect to all three concepts is affected by changes in the communication policy of the Fed, where the strongest positive effect on consistency comes from the introduction of the official inflation target. Finally, we show that consumers with theory-consistent expectations have lower absolute inflation forecast errors and are closer to professionals' inflation forecasts.

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Paper provided by KOF Swiss Economic Institute, ETH Zurich in its series KOF Working papers with number 13-345.

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Length: 33 pages
Date of creation: Nov 2013
Date of revision:
Handle: RePEc:kof:wpskof:13-345
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  10. Baghestani, Hamid & Kherfi, Samer, 2008. "How well do U.S. consumers predict the direction of change in interest rates?," The Quarterly Review of Economics and Finance, Elsevier, vol. 48(4), pages 725-732, November.
  11. Mankiw, N. Gregory & Reis, Ricardo & Wolfers, Justin, 2003. "Disagreement about Inflation Expectations," Research Papers 1807, Stanford University, Graduate School of Business.
  12. Fendel, Ralf & Frenkel, Michael & Rülke, Jan-Christoph, 2011. "'Ex-ante' Taylor rules - Newly discovered evidence from the G7 countries," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 224-232, June.
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  23. Menno Middeldorp, 2011. "FOMC communication policy and the accuracy of Fed Funds futures," Staff Reports 491, Federal Reserve Bank of New York.
  24. John B. Carlson & Ben Craig & Patrick Higgins & William R. Melick, 2006. "FOMC communications and the predictability of near-term policy decisions," Economic Commentary, Federal Reserve Bank of Cleveland, issue Jun.
  25. Richard T. Curtin, 2003. "Unemployment Expectations: The Impact of Private Information on Income Uncertainty," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 49(4), pages 539-554, December.
  26. Michael Ehrmann & Marcel Fratzscher, 2007. "Communication by Central Bank Committee Members: Different Strategies, Same Effectiveness?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 509-541, 03.
  27. Charles T. Carlstrom & Timothy S. Fuerst, 2008. "Explaining apparent changes in the Phillips curve: the Great Moderation and monetary policy," Economic Commentary, Federal Reserve Bank of Cleveland, issue Feb.
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