State-Dependent Sticky Expectations: Evidence and Theory

Kenneth Eva, Michael J. Lamla and Damjan Pfajfar

No 25-23, Working Papers from Federal Reserve Bank of Cleveland

Abstract: We document novel stylized facts regarding updating of households' inflation expectations. Using two randomized controlled trials fielded in the US and Germany where signals in the form of professionals' inflation forecasts have different perceived levels of precision, we show that households react more to information with higher levels of precision, in line with Bayesian updating. However, in contrast to Bayesian updating, they mostly respond differently to these signals in the decision to update expectations (extensive margin) and not in the size of the adjustment (intensive margin). The extensive margin also displays a pronounced asymmetry: Households more frequently update their expectations when the signal is above the prior compared to when the signal is below the prior. We propose a model where households' inflation expectations exhibit state-dependent inattentiveness to inflation signals. In times of high uncertainty, elevated inflation expectations may persist due to the increased information processing costs of uncertain inflation signals and the relatively smaller welfare losses of not adjusting expectations when signals are below priors (disinflations) compared to when signals are above priors (accelerating inflation). Our model provides microfoundations for the asymmetric loss function that is commonly assumed to explain biases in inflation expectations.

Keywords: inflation expectations; rational inattention; signal uncertainty; randomized controlled trial; survey experiment (search for similar items in EconPapers)
JEL-codes: D84 E31 E52 E58 (search for similar items in EconPapers)
Pages: 59
Date: 2025-10-14
New Economics Papers: this item is included in nep-exp and nep-mon
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Working Paper: State-dependent sticky expectations: Evidence and theory (2025)
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DOI: 10.26509/frbc-wp-202523

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