Who Cares about Inflation? Endogenous Expectation Formation of Heterogeneous Households

55 Pages Posted: 12 Aug 2022

See all articles by Lukas Nord

Lukas Nord

European University Institute - Department of Economics

Date Written: July 14, 2022

Abstract

This paper builds a joint theory of endogenous inflation expectations and consumption-savings choices of heterogeneous households. We introduce imperfect information about future inflation rates in a consumption-savings model and allow households to exert costly effort to reduce uncertainty about future price changes. High wealth households are more exposed to future inflation due to its effect on real interest rates and hence choose to be better informed. The joint distribution of wealth and inflation expectations generated by the model is consistent with key features of the data. The implied consumption response to news about inflation is hump shaped in wealth: Wealthier households pay closer attention and update their expectations more in response to any signal received, but change their consumption less after any given update in expectations due to the income effect of future inflation. We show this mechanism to reduce the on-impact aggregate consumption response to forward guidance policies by up to 55% compared to an attentive counterfactual.

Keywords: Household Heterogeneity, Expectation Formation, Inflation Expectations

JEL Classification: D31, D84, E21, E31

Suggested Citation

Nord, Lukas, Who Cares about Inflation? Endogenous Expectation Formation of Heterogeneous Households (July 14, 2022). Available at SSRN: https://ssrn.com/abstract=4185726 or http://dx.doi.org/10.2139/ssrn.4185726

Lukas Nord (Contact Author)

European University Institute - Department of Economics ( email )

Italy

HOME PAGE: http://lukasnord.eu

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