Misperceived Law of Motion in Macroeconomic Expectations

Abstract

This paper offers a new empirical method to detect discrepancies between perceived and actual laws of motion across a broad range of expectation formation models. This method hinges on a theoretical observation: when perceived and actual laws of motion align, the cross-covariance between consensus expectations reported at the same period and the corresponding outcomes forms a symmetric matrix. By selecting expectations of different variables and their forecasts over multiple horizons, one can detect various types of discrepancies. Applications of this method reveal that consumers oversimplify the processes of growth and inflation, while professional forecasters overcomplicate the interest rate dynamics.

Keywords: Misperceived Law of Motion, Survey Expectations, Decisive Evidence

JEL Classification: C53, D83, D84, E70