IDEAS home Printed from https://ideas.repec.org/p/spa/wpaper/2013wpecon11.html
   My bibliography  Save this paper

Inflation Targeting and Macroeconomic Stability with Heterogeneous Inflation Expectations

Author

Listed:
  • Gilberto Tadeu Lima

    ()

  • Mark Setterfield, Jaylson Jair da Silveira

Abstract

Drawing on an extensive empirical literature that suggests persistent and time-varying heterogeneity in inflation expectations, this paper embeds two inflation forecasting heuristics – one based on the current rate of inflation, the second anchored to the official inflation target – in a simple macrodynamic model. Decision makers switch between these forecasting heuristics based on satisficing evolutionary dynamics. We show that convergence towards an equilibrium consistent with the level of output and rate of inflation targeted by policy makers is achieved regardless of whether or not the satisficing evolutionary dynamics that guide the choices agents make between inflation forecasting strategies are subject to noise. We also show that full credulity – a situation where all agents eventually use the forecasting heuristic based on the target rate of inflation – is neither a necessary condition for realization of the inflation target, nor an inevitable consequence of the economy’s achievement of this target. These results demonstrate that uncertainty in decision making resulting in norm-based inflation expectations that are both heterogeneous and time-varying need not thwart the successful conduct of macroeconomic policy.

Suggested Citation

  • Gilberto Tadeu Lima & Mark Setterfield, Jaylson Jair da Silveira, 2013. "Inflation Targeting and Macroeconomic Stability with Heterogeneous Inflation Expectations," Working Papers, Department of Economics 2013_11, University of São Paulo (FEA-USP), revised 25 Nov 2016.
  • Handle: RePEc:spa:wpaper:2013wpecon11
    as

    Download full text from publisher

    File URL: http://www.tandfonline.com/doi/abs/10.2753/PKE0160-3477370204.2015.11082990
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Diron, Marie & Mojon, Benoît, 2005. "Forecasting the central bank's inflation objective is a good rule of thumb," Working Paper Series 564, European Central Bank.
    2. Setterfield, Mark, 2007. "The rise, decline and rise of incomes policies in the US during the post-war era: an institutional-analytical explanation of inflation and the functional distribution of income," Journal of Institutional Economics, Cambridge University Press, vol. 3(02), pages 127-146, August.
    3. David G. Blanchflower & Conall MacCoille, 2009. "The formation of inflation expectations: an empirical analysis for the UK," NBER Working Papers 15388, National Bureau of Economic Research, Inc.
    4. N. Gregory Mankiw & Ricardo Reis & Justin Wolfers, 2004. "Disagreement about Inflation Expectations," NBER Chapters,in: NBER Macroeconomics Annual 2003, Volume 18, pages 209-270 National Bureau of Economic Research, Inc.
    5. Klaus Adam, 2007. "Experimental Evidence on the Persistence of Output and Inflation," Economic Journal, Royal Economic Society, vol. 117(520), pages 603-636, April.
    6. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1295-1328.
    7. Michael W. M. Roos & Wolfgang J. Luhan, 2013. "Information, Learning and Expectations in an Experimental Model Economy," Economica, London School of Economics and Political Science, vol. 80(319), pages 513-531, July.
    8. Carlos Capistrán & Allan Timmermann, 2009. "Disagreement and Biases in Inflation Expectations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(2-3), pages 365-396, March.
    9. David Dequech, 2004. "Uncertainty: individuals, institutions and technology," Cambridge Journal of Economics, Oxford University Press, vol. 28(3), pages 365-378, May.
    10. Pfajfar, Damjan & Santoro, Emiliano, 2010. "Heterogeneity, learning and information stickiness in inflation expectations," Journal of Economic Behavior & Organization, Elsevier, vol. 75(3), pages 426-444, September.
    11. Simon, Herbert A, 1978. "Rationality as Process and as Product of Thought," American Economic Review, American Economic Association, vol. 68(2), pages 1-16, May.
    12. Branch, William A. & McGough, Bruce, 2010. "Dynamic predictor selection in a new Keynesian model with heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 34(8), pages 1492-1508, August.
    13. Assenza, T. & Heemeijer, P. & Hommes, C.H. & Massaro, D., 2011. "Individual Expectations and Aggregate Macro Behavior," CeNDEF Working Papers 11-01, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
    14. Kandori, Michihiro & Mailath, George J & Rob, Rafael, 1993. "Learning, Mutation, and Long Run Equilibria in Games," Econometrica, Econometric Society, vol. 61(1), pages 29-56, January.
    15. Christopher D. Carroll, 2003. "Macroeconomic Expectations of Households and Professional Forecasters," The Quarterly Journal of Economics, Oxford University Press, vol. 118(1), pages 269-298.
    16. 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, July.
    17. Gilberto Tadeu Lima & Mark Setterfield, 2008. "Inflation targeting and macroeconomic stability in a Post Keynesian economy," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 30(3), pages 435-461, April.
    18. Alex Brazier & Richard Harrison & Mervyn King & Tony Yates, 2008. "The Danger of Inflating Expectations of Macroeconomic Stability: Heuristic Switching in an Overlapping-Generations Monetary Model," International Journal of Central Banking, International Journal of Central Banking, vol. 4(2), pages 219-254, June.
    19. Pfajfar, D. & Zakelj, B., 2011. "Inflation Expectations and Monetary Policy Design : Evidence from the Laboratory (Replaces CentER DP 2009-007)," Discussion Paper 2011-091, Tilburg University, Center for Economic Research.
    20. Sujit Kapadia, 2005. "Inflation-Target Expectations and Optimal Monetary Policy," Economics Series Working Papers 227, University of Oxford, Department of Economics.
    21. Hommes,Cars, 2015. "Behavioral Rationality and Heterogeneous Expectations in Complex Economic Systems," Cambridge Books, Cambridge University Press, number 9781107564978.
    22. Weber, Anke, 2007. "Heterogeneous expectations, learning and European inflation dynamics," Discussion Paper Series 1: Economic Studies 2007,16, Deutsche Bundesbank.
    23. William A. Brock & Cars H. Hommes, 1997. "A Rational Route to Randomness," Econometrica, Econometric Society, vol. 65(5), pages 1059-1096, September.
    24. Hommes, Cars, 2011. "The heterogeneous expectations hypothesis: Some evidence from the lab," Journal of Economic Dynamics and Control, Elsevier, vol. 35(1), pages 1-24, January.
    25. Paul Davidson, 1996. "Reality and Economic Theory," Journal of Post Keynesian Economics, Taylor & Francis Journals, vol. 18(4), pages 479-508, July.
    26. Cornwall,John & Cornwall,Wendy, 2001. "Capitalist Development in the Twentieth Century," Cambridge Books, Cambridge University Press, number 9780521341493.
    27. Gale, John & Binmore, Kenneth G. & Samuelson, Larry, 1995. "Learning to be imperfect: The ultimatum game," Games and Economic Behavior, Elsevier, vol. 8(1), pages 56-90.
    28. Mark Setterfield, 2006. "Is inflation targeting compatible with Post Keynesian economics?," Journal of Post Keynesian Economics, Taylor & Francis Journals, vol. 28(4), pages 653-671.
    29. Branch, William A., 2007. "Sticky information and model uncertainty in survey data on inflation expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 245-276, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Mark Setterfield, 2014. "Using Interest Rates as the Instrument of Monetary Policy: Beware Real effects, Positive Feedbacks, and Discontinuities," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(70), pages 7-22, June.

    More about this item

    Keywords

    Inflation targeting; macroeconomic stability; heterogeneous expected inflation; satisficing evolutionary dynamics;

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spa:wpaper:2013wpecon11. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Pedro Garcia Duarte). General contact details of provider: http://edirc.repec.org/data/deuspbr.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.