Finance and Economics Discussion Series (FEDS)
August 2018
The Role of Expectations in Changed Inflation Dynamics
Damjan Pfajfar and John M. Roberts
Abstract:
The Phillips curve has been much flatter in the past twenty years than in the preceding decades. We consider two hypotheses. One is that prices at the microeconomic level are stickier than they used to be---in the context of the canonical Calvo model, firms are adjusting prices less often. The other is that the expectations of firms and households about future inflation are now less well informed by macroeconomic conditions; because expectations are important in the setting of current-period prices, inflation is therefore less sensitive to macroeconomic conditions. To distinguish between our two hypotheses, we bring to bear information on inflation expectations from surveys, which allow us to distinguish changes in the sensitivity of inflation to economic conditions conditioning on expectations from changes in the sensitivity of expectations themselves to economic conditions. We find that, with some measures, expectations are less tied to economic conditions than i n the past, and thus that this reduced attentiveness can account for a significant portion of the reduction in the sensitivity of inflation to economic conditions in recent decades.
Acessible materials (.zip)
Keywords: Inflation dynamics, Phillips curve, Survey Inflation Expectations
DOI: https://doi.org/10.17016/FEDS.2018.062
PDF: Full Paper