A Time-Varying Expectations Formation Mechanism

Bovi, Maurizio (2019): A Time-Varying Expectations Formation Mechanism. Published in: Economia Politica No. 4 (December 2019)

Abstract

We propose an expectations formation mechanism (EFM) aimed to explain the median – hence lay – forecaster’s year-ahead inflation predictions. The EFM is a time-varying combination of long-run expectations, current inflation and uncertainty with weights naively calibrated according to inflation dynamics. Earning fixed income, in fact, the median forecaster has an aversion toward underestimation that increases with inflation. To allow for occasional – albeit unintentional – cost-minimizing calibrations, the EFM nests various forecasting rules. Data from the Michigan Survey of Consumers sustains the argued behavior and contributes to interpret some puzzling price dynamics such as the missing disinflation and reflation.

• Item Type: MPRA Paper
• Language: English
• Keywords: Survey expectations, Inflation, Time-Varying Parameters
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C53 - Forecasting and Prediction Methods ; Simulation Methods; C - Mathematical and Quantitative Methods > C8 - Data Collection and Data Estimation Methodology ; Computer Programs > C83 - Survey Methods ; Sampling Methods; E - Macroeconomics and Monetary Economics > E0 - General > E03 - Behavioral Macroeconomics

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