The Mechanism of Inflation Expectation Formation among Consumers
How do we determine our expectations of inflation? Because inflation expectations greatly influence the economy, researchers have long considered this question. Using a survey with randomized experiments among 15,000 consumers, we investigate the mechanism of inflation expectation formation. Learning theory predicts that once people obtain new information on future inflation, they change their expectations. In this regard, such expectations are the weighted average of prior belief and information. We confirm that the weight for prior belief is a decreasing function of the degree of uncertainty. Our results also show that monetary authority information affects consumers to a greater extent when expectations are updated. With such information, consumers change their inflation expectations by 32% from the average. This finding supports improvements to monetary policy publicity
Expectations vis-à-vis future inflation are very important for economic decision-making. People contemplate the future on many occasions, including when they consider how much to save, or whether to postpone the purchase of a house or not. Thus, economists have been discussing what inflation expectations are, how they influence the overall dynamics of the economy, and how they are formed. Occasionally, such expectations become central to policy debates because the effectiveness of some types of monetary policies crucially depends upon how these are formed (Blinder, 2000; McCallum, 1984; Sargent, 1982). In spite of their long history, inflation expectations have also been renowned for being difficult to measure (Mankiw et al., 2004; Schwarz, 1999).