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Expectations and the Rate of Inflation

Author

Listed:
  • Iván Werning
Abstract
What is the effect of higher expectations of future inflation on current inflation? I compute this passthrough for a series of canonical firm-pricing models, but allowing for arbitrary (non-rational) expectations. In the Calvo model, the expectational-passthrough can be made arbitrarily close to zero for sufficiently high stickiness, but in practice, for reasonable parameters, passthrough is close to its upper bound of 1. In the Taylor model, in contrast, the upper bound for passthrough is ½ instead of 1. For a general time-dependent model I show that: (i) passthrough is given by a measurable sufficient statistic: the ratio of the average duration of ongoing price spells to that of completed price spells; (ii) the lowest theoretically possible passthrough equals ½ by Taylor pricing; and (iii) passthrough can be theoretically greater than 1 with hazards that decrease over time; (iv) breaking down the passthrough across horizons, it is expectations in the near future that matters the most, expectations of long-run inflation are completely irrelevant; (v) I provide a generalized Phillips curve for current inflation as a linear function of expectations of future inflation and realized past inflations; (vi) I show that the sum of all coefficients, both past and future, sums to one, so that the long-run Phillips curve is vertical. Finally, I study state-dependent “menu cost” models and show that passthrough in these models can be extremely low or extremely high, depending on the exact specification and inflation rate. I suggest a model where firms must pay a fixed cost for changing their sS pricing policy bands. This extension gives a passthrough of 0 for small enough changes in expectations.

Suggested Citation

  • Iván Werning, 2022. "Expectations and the Rate of Inflation," NBER Working Papers 30260, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:30260
    Note: EFG ME
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    Cited by:

    1. Demgensky, Lisa & Fritsche, Ulrich, 2023. "Narratives on the causes of inflation in Germany: First results of a pilot study," WiSo-HH Working Paper Series 77, University of Hamburg, Faculty of Business, Economics and Social Sciences, WISO Research Laboratory.
    2. Buchheim, Lukas & Link, Sebastian & Möhrle, Sascha, 2024. "Inflation and Wage Expectations of Firms and Employees," IZA Discussion Papers 17269, Institute of Labor Economics (IZA).
    3. Chen, Pu & Semmler, Willi, 2024. "Wage – price dynamics and financial market in a disequilibrium macro model: A Keynes – Kaldor – Minsky modeling of recession and inflation using VECM," Journal of Economic Behavior & Organization, Elsevier, vol. 220(C), pages 433-452.
    4. Lena Anayi & Nicholas Bloom & Philip Bunn & Paul Mizen & Gregory Thwaites & Ivan Yotzov, 2022. "Firming up price inflation," POID Working Papers 058, Centre for Economic Performance, LSE.
    5. Ethan Ilzetzki, 2024. "Fiscal Events and Anchored Inflation Expectations," Discussion Papers 2410, Centre for Macroeconomics (CFM).
    6. Andryushin, S., 2024. "Interest rate policy of the Bank of Russia in conditions of fiscally-dominant regime: Risks and prospects," Journal of the New Economic Association, New Economic Association, vol. 62(1), pages 211-219.
    7. Herzog, Bodo, 2023. "How credible is average and symmetric inflation targeting in an episode of high inflation?," Economic Analysis and Policy, Elsevier, vol. 80(C), pages 1750-1761.

    More about this item

    JEL classification:

    • E03 - Macroeconomics and Monetary Economics - - General - - - Behavioral Macroeconomics
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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