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Biased Inflation Forecasts

Author

Listed:
  • Hassan Afrouzi

    (Columbia University)

  • Laura Veldkamp

    (Columbia University)

Abstract
Recent work finds that people's beliefs about inflation are systematically upward biased. Since inflation expectations are central to the efficacy of monetary policy, understanding these expectations, and their biases, is important for policy. While one can always find preference-based explanations for bias, the fact that more informed agents have less upward bias, suggests some connection to information, as opposed to preferences. This paper proposes a rational Bayesian explanation for the bias: Agents with parameter uncertainty over positively-skewed distributions have a positive bias in their forecast. We use inflation and survey data to show that this mechanism can quantitatively explain the magnitude of the bias. The model implies that communicating about inflation skewness may be an important dimension of forward guidance.

Suggested Citation

  • Hassan Afrouzi & Laura Veldkamp, 2019. "Biased Inflation Forecasts," 2019 Meeting Papers 894, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:894
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    References listed on IDEAS

    as
    1. Lars Peter Hansen & Thomas J Sargent, 2014. "Beliefs, Doubts and Learning: Valuing Macroeconomic Risk," World Scientific Book Chapters, in: UNCERTAINTY WITHIN ECONOMIC MODELS, chapter 10, pages 331-377, World Scientific Publishing Co. Pte. Ltd..
    2. Bartosz Mackowiak & Mirko Wiederholt, 2009. "Optimal Sticky Prices under Rational Inattention," American Economic Review, American Economic Association, vol. 99(3), pages 769-803, June.
    3. Michael F. Bryan & Brent Meyer & Nicholas B. Parker, 2014. "The inflation expectations of firms: what do they look like, are they accurate, and do they matter?," FRB Atlanta Working Paper 2014-27, Federal Reserve Bank of Atlanta.
    4. Saten Kumar & Hassan Afrouzi & Olivier Coibion & Yuriy Gorodnichenko, 2015. "Inflation Targeting Does Not Anchor Inflation Expectations: Evidence from Firms in New Zealand," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 46(2 (Fall)), pages 151-225.
    5. Timothy Cogley & Thomas J. Sargent, 2005. "The conquest of US inflation: Learning and robustness to model uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 528-563, April.
    6. Christopher D. Carroll, 2003. "Macroeconomic Expectations of Households and Professional Forecasters," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(1), pages 269-298.
    7. Anmol Bhandari & Jaroslav Borovicka & Paul Ho, 2019. "Survey Data and Subjective Beliefs in Business Cycle Models," Working Paper 19-14, Federal Reserve Bank of Richmond.
    8. Lars Peter Hansen, 2007. "Beliefs, Doubts and Learning: Valuing Economic Risk," NBER Working Papers 12948, National Bureau of Economic Research, Inc.
    9. Hui Chen & Winston Wei Dou & Leonid Kogan, 2019. "Measuring “Dark Matter” in Asset Pricing Models," NBER Working Papers 26418, National Bureau of Economic Research, Inc.
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    Citations

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    Cited by:

    1. Gorodnichenko, Yuriy & Sergeyev, Dmitriy, 2021. "Zero Lower Bound on Inflation Expectations," IZA Discussion Papers 14853, Institute of Labor Economics (IZA).
    2. Kenneth Eva & Fabian Winkler, 2023. "A Comprehensive Empirical Evaluation of Biases in Expectation Formation," Finance and Economics Discussion Series 2023-042, Board of Governors of the Federal Reserve System (U.S.).

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