The Price is Right: Updating of Inflation Expectations in a Randomized Price Information Experiment

Abstract

Understanding the formation of consumer inflation expectations is considered crucial for managing monetary policy. Using a unique 'information' experiment embedded in a survey, this paper investigates how consumers’ inflation expectations respond to new information. We elicit respondents’ expectations for future inflation before and after providing a random subset of respondents with factual information that may affect their expectations. This design creates unique panel data that allow us to identify causal effects of new information. We find, first, that baseline inflation expectations are right-skewed, and that consumers in the high-expectation right tail are relatively under-informed about objective, inflation-relevant facts. We next find that providing consumers with new information causes them to update their expectations, such that the expectations distribution converges toward its center. Furthermore, respondents who update do so in sensible ways: revisions are proportional to the strength of the information signal, and inversely proportional to the precision of baseline inflation expectations. Our findings indicate that heterogeneous consumer expectations are a result of both different information sets, as well as different information-processing rules. Overall, our results are consistent with a Bayesian learning model. We discuss implications of these results for monetary policy and for macro-economic modeling.

Keywords: inflation expectations, information, heterogeneous expectations, updating

JEL Classification: C81, D80, E31