Biases in Survey Inflation Expectations: Evidence from the Euro Area

Biases in Survey Inflation Expectations: Evidence from the Euro Area By Jiaqian Chen, Lucyna Gornicka, and Vaclav Zdarek WP/22/205IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 2022 SEP © 2022 International Monetary Fund WP/22/205IMF Working Paper Strategy, Policy and Review Department and Monetary and Capital Market Department Biases in Survey Inflation Expectations: Evidence from the Euro Area Prepared by Jiaqian Chen*, Lucyna Górnicka†, and Vaclav Zdarek‡ Authorized for distribution by Stephan Danninger and Gaston Gelos September 2022 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. ABSTRACT: This paper documents five facts about inflation expectations in the euro area. First, individual inflation forecasts overreact to individual news. Second, the cross-section average of individual forecasts of inflation underreact to shocks initially, but overreacts in the medium term. Third, disagreement about future inflation increases in response to news when the current inflation is high, and declines when inflation is low, consistent with a zero lower bound of expectations. Fourth, overreaction of individual inflation forecasts to news increased after the global financial crisis (GFC). Fifth, the reaction of average expectations (and of actual inflation) to shocks became more muted post-GFC in the euro area, but not in the U.S. JEL Classification Numbers: E3, E4, E5, D83, D84 Keywords: expectations formation; surveys of expectations; informational rigidities The views expressed in this paper are those of the authors and do not necessarily represent those of the European Commission, Directorate-General for Economic and Financial Affairs (DG ECFIN), the International Monetary Fund, its Board or Management. We thank Roberta Friz and Christian Gayer for comments and help with BCS Survey data, Elena Bobeica and Marek Jarocinski for sharing their data and codes, Wouter van der Wielen for his advice on fiscal VAR. We thank Stephan Danninger, Christopher Erceg, Gaston Gelos, Gita Gopinath, Kenneth Kang, Jesper Linde, Pawel Zabczyk and other seminar participants at the IMF for useful comments. All remaining errors are under the full responsibility of the authors. *I nternational Monetary Fund, Jchen@imf.org† International Monetary Fund, Lgornicka@imf.org‡ European Commission, Vaclav.zdarek1@ec.europa.eu WORKING PAPERS Biases in Survey Inflation Expectations: Evidence from the Euro Area Prepared by Jiaqian Chen, Lucyna Gornicka, and Vaclav Zdarek1 1 The views expressed in this paper are those of the authors and do not necessarily represent those of the European Commission, Directorate-General for Economic and Financial Affairs (DG ECFIN), the International Monetary Fund, its Board or Management. We thank Roberta Friz and Christian Gayer for comments and help with BCS Survey data, Elena Bobeica and Marek Jarocinski for sharing their data and codes, Wouter van der Wielen for his advice on fiscal VAR. We thank Stephan Danninger, Christopher Erceg, Gaston Gelos, Gita Gopinath, Kenneth Kang, Jesper Linde, Pawel Zabczyk and other seminar participants at the IMF for useful comments. All remaining errors are under the full responsibility of the authors. IMF WORKING PAPERSBiases in survey inflation expectationsContents1 Introduction32 Literature73 A simple model: understanding over- and under-reaction84 Data104.1 Data on consumers’ expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . 104.2 Data on professional forecasters’ expectations . . . . . . . . . . . . . . . . . . . . 144.3 Other data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155 Individual inflation expectations166 Behavior of average expectations186.1 Average forecast errors and forecast revisions . . . . . . . . . . . . . . . . . . . . 186.2 Responses of inflation expectations to macroeconomic shocks . . . . . . . . . . . 196.3 Results for inflation expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . 216.4 Results for unemployment expectations . . . . . . . . . . . . . . . . . . . . . . . 256.5 Robustness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267 Disagreement about future inflation288 Expectations post-GFC328.1 Indivi