Memory and Beliefs: Evidence from the Field
Michael Weber, Assistant Professor of Finance
This project aims to understand how ordinary people form expectations and the role of memory in the expectations formation process. We will focus especially on inflation expectations of households which are crucial determinants of consumption, savings, and wage-bargaining decisions and hence ultimately determine the effectiveness of fiscal and monetary policy interventions. While central banks typically assume that inflation expectations are well anchored and academic research often postulates the paradigm of a representative agent who forms expectations rationally, mounting evidence documents large heterogeneity in expectations and substantial deviations from the full-information rational benchmark. Recently, the recovery from the Covid-19 pandemic produced a sharp increase in realized inflation which has swiftly translated in a jump of households’ inflation expectations to unprecedented levels. At the same time, the last decade has underscored the role of unconventional monetary policy tools such as forward guidance that operate through decision-makers’ expectations in times of low policy rates. Inspired by all this evidence, this proposal aims to understand how households form their macroeconomic expectations and if and how central banks can manage such expectations. To this aim, we plan to merge unique micro data on households’ consumption spending with customized surveys to elicit their inflation expectations and assess their recall of past price changes. This unique setting allows us to study how memory of past prices is formed and varies across agents and whether it helps explain their inflation expectations. This inquiry connects recent advances in the application of insights from cognitive psychology to economics with the recent strand of macroeconomics that studies the sources of heterogeneity in macroeconomic expectations.