The Role of Expectations in Changed Inflation Dynamics

47 Pages Posted: 17 Sep 2018 Last revised: 21 Feb 2019

See all articles by Damjan Pfajfar

Damjan Pfajfar

Board of Governors of the Federal Reserve System

John M. Roberts

Board of Governors of the Federal Reserve System

Date Written: 2018-08-31

Abstract

The Phillips curve has been much flatter in the past twenty years than in the preceding decades. We consider two hypotheses. One is that prices at the microeconomic level are stickier than they used to be---in the context of the canonical Calvo model, firms are adjusting prices less often. The other is that the expectations of firms and households about future inflation are now less well informed by macroeconomic conditions; because expectations are important in the setting of current-period prices, inflation is therefore less sensitive to macroeconomic conditions. To distinguish between our two hypotheses, we bring to bear information on inflation expectations from surveys, which allow us to distinguish changes in the sensitivity of inflation to economic conditions conditioning on expectations from changes in the sensitivity of expectations themselves to economic conditions. We find that, with some measures, expectations are less tied to economic conditions than in the past, and thus that this reduced attentiveness can account for a significant portion of the reduction in the sensitivity of inflation to economic conditions in recent decades.

Keywords: Phillips curve, Survey inflation expectations, Inflation dynamics

JEL Classification: E31, E37

Suggested Citation

Pfajfar, Damjan and Roberts, John M., The Role of Expectations in Changed Inflation Dynamics (2018-08-31). FEDS Working Paper No. 2018-062. Available at SSRN: https://ssrn.com/abstract=3245056 or http://dx.doi.org/10.17016/FEDS.2018.062

Damjan Pfajfar (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

John M. Roberts

Board of Governors of the Federal Reserve System ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2946 (Phone)

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