Inflation as a 'bad', heuristics and aggregate shocks: New evidence on expectation formation
Melbourne Institute Working Paper No. 03/24
Date: May 2024
Author(s):
Abstract
This paper studies how inflation expectations are formed, how they are influenced by Inflation-as-a-Bad (IAAB) perceptions, and how these perceptions relate to economic shocks. IAAB perceptions significantly alter inflation expectations, causing spikes, positive bias, and deviations from the Phillips Curve. These perceptions have a distinct impact from canonical properties such as information rigidities, over-reaction, and rationality, which fail to adequately characterize consumer inflation expectations. A model combining rational expectations, information frictions, and consumer heuristics effectively explains the time-variation in the inflation expectations of 365,000 consumers.