Inflation Announcements and Social Dynamics
54 Pages Posted: 7 Sep 2013 Last revised: 6 Apr 2017
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Inflation Announcements and Social Dynamics
Inflation Announcements and Social Dynamics
Date Written: April 2017
Abstract
We propose a new framework for understanding the effectiveness of central bank announcements when firms have heterogeneous inflation expectations. Expectations are updated through social dynamics and, with heterogeneity, not all firms choose to operate, putting downward pressure on realized inflation. Our model rationalizes why countries stuck at the zero lower bound have had a hard time increasing inflation with- out being aggressive. The same model also predicts that announcing an abrupt target to disinflate will cause inflation to undershoot the target whereas announcing gradual targets will not. We present new empirical evidence that corroborates this prediction.
Keywords: central bank communication, expectations heterogeneity, social dynamics, credibility, inflation targeting, quantitative easing
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