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Asymmetric In?ation Expectations, Downward Rigidity of Wages,and Asymmetric Business Cycles

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  • David R Baqaee

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.
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Suggested Citation

  • David R Baqaee, 2014. "Asymmetric In?ation Expectations, Downward Rigidity of Wages,and Asymmetric Business Cycles," Working Paper 139681, Harvard University OpenScholar.
    • Handle: RePEc:qsh:wpaper:139681
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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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