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Working Paper
Inflation Expectations with Finite Horizon Planning
Under finite horizon planning, households and firms evaluate a full set of state-contingent paths along which the economy might evolve out to a finite horizon but have limited ability to process events beyond that horizon. We show--analytically and empirically--that such a model accounts for an initial underreaction and subsequent overreaction of inflation forecasts. A planning horizon of four quarters can account for the evidence on the predictability of inflation forecast errors and macroeconomic data. Our identification and estimation strategies combine full-information methods based ...
Working Paper
Government Debt, Limited Foresight, and Longer-term Interest Rates
We study the relationship between government debt and interest rates in an environment where financial market participants have limited foresight about the future path of government debt. We show that limited foresight substantially attenuates estimates of the effect of government debt on longer-term yields relative to the benchmark of rational expectations often used in empirical analysis.
Working Paper
The Optimal Monetary Policy Response to Belief Distortions: Model-Free Evidence
Data suggest that monetary policy should ease to offset inflation over-pessimism among households.
Working Paper
Do Monetary Policy Announcements Shift Household Expectations?
We use a decade of daily survey data from Gallup to study how monetary policy influences households' beliefs about economic conditions. We first document that public confidence in the state of the economy reacts instantaneously to certain types of macroeconomic news. Next, we show that surprises to the Federal Funds target rate are among the news that have statistically significant and instantaneous effects on economic confidence. Specifically, we find that a surprise increase in the target rate robustly leads to an immediate decline in household confidence, at odds with previous findings ...
Working Paper
Optimal Monetary Policy with Uncertain Private Sector Foresight
Central banks operate in a world in which there is substantial uncertainty regarding the transmission of its actions to the economy because of uncertainty regarding the formation of private-sector expectations. We model private sector expectations using a finite horizon planning framework: Households and firms have limited foresight when deciding spending, saving, and pricing decisions. In this setting, contrary to standard New Keynesian (NK) models, we show that "an inflation scares problem" for the central bank can arise where agents' longer-run inflation expectations deviate persistently ...
Working Paper
Inflation since the Pandemic: Lessons and Challenges
This paper reviews the drivers of the post-pandemic U.S. inflation surge and subsequent decline, including the behavior and role of inflation expectations. The sharp rise in inflation reflected severe imbalances between supply and demand stemming from the shocks of the pandemic and the policy response. Measures of short-term inflation expectations increased alongside realized inflation, especially those of households and firms, which may have contributed to inflation's persistence through price- and wage-setting behavior. However, measures of longer-term inflation expectations remained ...
Working Paper
How Ricardian Are We?
Not very. To answer this question, we conjecture that households might be non-Ricardian because they do not have rational expectations over their future tax burden. From this assumption, we derive a behavioral consumption function, where households act as if bonds are net wealth and consume out of taxes and transfers. The coefficient on taxes is determined by the attenuation present in households’ behavioral expectations. This consumption function also nests other causes of non-Ricardianism, including liquidity constraints and overlapping generations. To estimate the coefficient, we derive ...
Working Paper
Mis-specified Forecasts and Myopia in an Estimated New Keynesian Model
The paper considers a New Keynesian framework in which agents form expectations based on a combination of autoregressive mis-specified forecasts and myopia. The proposed expectations formation process is shown to be consistent with all three empirical facts on consensus inflation forecasts. However, while mis-specified forecasts can be both sufficient and necessary to match all three facts, myopia alone is neither. The paper then derives the general equilibrium solution consistent with the proposed expectations formation process and estimates the model with likelihood-based Bayesian methods, ...
Report
Paradoxes and Problems in the Causal Interpretation of Equilibrium Economics
Equilibrium assumptions posit relations between different people's beliefs and behavior without describing a process that causes these relations to hold. I show that because equilibrium models do not describe a causal process whereby one endogenous variable affects another, attempts to decompose the effects of shocks into “direct” and “indirect” effects can suggest misleading predictions about how these models work. Equilibrium assumptions also imply absurd paradoxes: history can determine future behavior without affecting any intervening state variables today; individuals can learn ...