Macroeconomic Expectations and Limited Awareness

Speaker: Prof Nicola Pavoni

Affiliation: Università Bocconi

Online via Zoom: https://uqz.zoom.us/j/84008636651

Abstract

Do agents understand well the determinants of the trade-off between output and inflation? What are the sources of their possible ‘mistakes’? We combine data on aggregate variables and individual expectations from the Survey of Professional Forecasters to derive a series of empirical facts about expectations, which can seen as test of Rational Expectations (RE). The first set of evidence revisits the regressions proposed by other authors at individual level (e.g., Bordalo et al. AER, 2020) and find 'overreaction' to news about inflation and 'under-reaction' to news about unemployment. The second set of results is based on cross-variable restrictions between forecast errors about inflation and past expected output. Our evidence rejects the RE hypothesis. We provide an interpretation of the empirical evidence based on agents that are unaware of supply shocks and, hence, commit an omitted variable bias when inferring the trade-off between output and inflation. The model is also able to generate at the same time over-reaction in inflation and under-reaction in unemployment. To study the implications of limited awareness for monetary policy, we construct an otherwise standard New Keynesian model where agents are not aware of all supply shocks affecting the economy. Among other results, we first show that the presence of limited aware agents increases the output costs of reducing inflation.  The model might help address some ‘puzzles’ of the New Keynesian setup.

About the presenter's meeting

If you would like to meet with Prof Pavoni, please contact Dr Zachary Breig