What can we learn from the distributions of inflation expectations across European households?

Quite a lot. We use a very large dataset of inflation expectations formed by households across the euro-area over the period 2004:1-2023:11 to assess the degree of existing heterogeneity, and whether features of the households’ cross-sectional distribution in these economies are informative for inflation realizations. We summarize the heterogeneity across households using a recent functional data approach, and show that the functional components affect inflation realizations across the euro-area. This points to a role for the distribution of inflation expectations in the Phillips Curve relation, beyond the role of consensus expectations implied by models which do not allow for such heterogeneity. Moreover, we find that the inflationary impact of the functional components differs across high-inflation and low-inflation environments. Importantly, empirical models that account for the distribution of past expectations of current inflation in addition to the distribution of current expectations of future inflation, do better during the period under study as compared to models that include only the forward-looking component, especially during turbulent times. This suggests that rational inattention models with heterogeneity would be a good starting point for building macroeconomic models which can give an empirically relevant Phillips Curve relation.