The Price is Right: Updating of Inflation Expectations in a Randomized Price Information Experiment

50 Pages Posted: 31 Jan 2012 Last revised: 3 Feb 2013

See all articles by Olivier Armantier

Olivier Armantier

Federal Reserve Bank of New York

Scott Nelson

Massachusetts Institute of Technology (MIT), Department of Economics, Students

Giorgio Topa

Federal Reserve Bank of New York

Wilbert van der Klaauw

Federal Reserve Bank of New York; IZA

Basit Zafar

Arizona State University

Date Written: March 8, 2012

Abstract

Understanding the formation of consumer inflation expectations is considered crucial for managing monetary policy. Using a unique 'information' experiment embedded in a survey, this paper investigates how consumers’ inflation expectations respond to new information. We elicit respondents’ expectations for future inflation before and after providing a random subset of respondents with factual information that may affect their expectations. This design creates unique panel data that allow us to identify causal effects of new information. We find, first, that baseline inflation expectations are right-skewed, and that consumers in the high-expectation right tail are relatively under-informed about objective, inflation-relevant facts. We next find that providing consumers with new information causes them to update their expectations, such that the expectations distribution converges toward its center. Furthermore, respondents who update do so in sensible ways: revisions are proportional to the strength of the information signal, and inversely proportional to the precision of baseline inflation expectations. Our findings indicate that heterogeneous consumer expectations are a result of both different information sets, as well as different information-processing rules. Overall, our results are consistent with a Bayesian learning model. We discuss implications of these results for monetary policy and for macro-economic modeling.

Keywords: inflation expectations, information, heterogeneous expectations, updating

JEL Classification: C81, D80, E31

Suggested Citation

Armantier, Olivier and Nelson, Scott and Topa, Giorgio and van der Klaauw, H. Wilbert and Zafar, Basit, The Price is Right: Updating of Inflation Expectations in a Randomized Price Information Experiment (March 8, 2012). FRB of New York Staff Report No. 543. Available at SSRN: https://ssrn.com/abstract=1995811 or http://dx.doi.org/10.2139/ssrn.1995811

Olivier Armantier

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Scott Nelson

Massachusetts Institute of Technology (MIT), Department of Economics, Students ( email )

50 Memorial Drive
Bldg E52
Cambridge, MA 02142
United States

Giorgio Topa

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

H. Wilbert Van der Klaauw

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-5916 (Phone)
212-720-1844 (Fax)

IZA ( email )

Basit Zafar (Contact Author)

Arizona State University ( email )

WP Carey School of Business, ASU
Tempe, AZ 85287
United States
9179326564 (Phone)

HOME PAGE: http://https://sites.google.com/site/basitakzafar/

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