The Role of Dispersed Information in Inflation and Inflation Expectations

Abstract

We solve a rational expectations model of price formation with nominal rigidity and information frictions analytically to study how dispersed information impacts inflation and inflation expectations, without imposing strong structural assumptions on the aggregate marginal cost. We derive a Phillips curve that links inflation, average inflation forecast (i.e., a first-order expectation), and the net effect of higher-order expectations (HOEs). We quantify the essential role of dispersed information in generating inflation inertia and predictable average nowcast and forecast errors. The estimated effect from dispersed information explains a significant inflation variation, and the net effect of HOEs provides a novel micro-foundation for markup shocks.

Keywords: Inflation dynamics; Dispersed information; Expectation formation; Higher-order expectations; Frequency domain method

JEL Classification: C11, D82, D83, E12, E31