Driving Forces of Inflation Expectations

This paper addresses some important issues regarding the nature of inflation expectations. By utilizing measures of inflation expectations formed by consumers and professionals, a series of empirical applications are performed to identify main driving forces of variations in inflation expectations. Tests of forecast efficiency consistently indicate that survey expectations are not rational, and thus the expectations of real-world economic actors, not rational agents in a model, are found to be what matter for price setting. As a logical consequence of these findings, we explore potential factors agents rely on when forecasting inflation by looking more closely on price changes in consumption expenditure categories as well as some key macroeconomic aggregates. Empirical results suggest that agents think differently how aggregate inflation evolves mainly due to the fact that each type of agents employs a distinct set of information, which can be interpreted as a dominant source of disagreement among agents.