Inflation Disagreement Weakens the Power of Monetary Policy

Ding Dong (), Zheng Liu, Pengfei Wang () and Min Wei

No 2024-27, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: Households often disagree in their inflation outlooks. We present novel empirical evidence that inflation disagreement weakens the power of forward guidance and conventional monetary policy. These empirical observations can be rationalized by a model featuring heterogeneous beliefs about the central banks’ inflation target. An agent who perceives higher future inflation also perceives a lower real interest rate and thus would like to borrow more to finance consumption, subject to borrowing constraints. Higher inflation disagreement would lead to a larger share of borrowing-constrained agents, resulting in more sluggish responses of aggregate consumption to changes in both current and expected future interest rates. This mechanism also provides a microeconomic foundation for Euler equation discounting that helps resolve the forward guidance puzzle.

Keywords: inflation uncertainty and disagreement; inflation expectations; heterogeneous beliefs; borrowing constraints; monetary policy; forward guidance (search for similar items in EconPapers)
JEL-codes: E21 E31 E52 E71 (search for similar items in EconPapers)
Pages: 66
Date: 2024-08-05
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mon
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Working Paper: Inflation Disagreement Weakens the Power of Monetary Policy (2024)
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DOI: 10.24148/wp2024-27

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