Asymmetric inflation expectations, downward rigidity of wages, and asymmetric business cycles

Abstract

Household expectations of the inflation rate are much more sensitive to inflation than to disinflation. To the extent that workers have bargaining power in wage determination, this asymmetry in their beliefs can make wages respond quickly to inflationary forces but sluggishly to deflationary ones. I microfound asymmetric household expectations using ambiguity-aversion: households, who do not know the quality of their information, overweight inflationary news since it reduces their purchasing power, and underweight deflationary news since it increases their purchasing power. I embed asymmetric beliefs into a general equilibrium model and show that, in such a model, monetary policy has asymmetric effects on employment, output, and wage inflation in ways consistent with the data. Although wages are downwardly rigid in this environment, monetary policy need not have a bias towards using inflation to grease the wheels of the labor market.

Is the Fisher effect asymmetric? Cointegration analysis and expectations measurement

“…Households' expectations are, therefore, once again, biased towards sensitivity to increases in inflation. Using the Michigan Survey of Inflation Expectations over the years 1983-2015, Baqaee (2020 finds that households do indeed adjust their inflation expectations more to increases in recent inflation than to decreases. However, he finds that the Philadelphia Fed Survey's professional forecasters do not exhibit the asymmetry.…”

“…Baqaee (2020) provides a related model of asymmetric inflation expectations. Households view higher inflation as raising costs more than equal disinflation lowers them, and households have Knightian uncertainty about the quality of price change information (e.g., news of higher inflation could be false).…”

“…Analysis of the post‐1980‐break Fisher effect using actual inflation as a proxy for expected inflation, as done in every paper in Table 1 as well as the present one, would then be distorted. The distortion, at least for the professional forecasters, would not be related to asymmetric response, because they did not exhibit it (Baqaee, 2020).…”

“…In the absence of linear cointegration there could, however, be a non‐linear relationship, perhaps asymmetric, mis‐specified using the linear approach. But if the Livingston economists have shared the professional forecasters' lack of asymmetric response (Baqaee, 2020), and if the Livingston economists have had no other non‐linear response, then not finding a linear cointegration would clearly suggest a minimal long‐run relationship between forecasts and actual inflation. We do, however, test for asymmetric cointegration between forecasted and actual inflation.…”

“…This article's purpose is to examine the Fisher effect while accounting for mismeasurement of expectations based on possible non‐linearity in the form of asymmetric expectation formation. The argument for asymmetry draws from behavioural economic hypotheses and findings related to loss aversion (Tversky & Kahneman, 1991) and a model of household inflation expectation formation with uncertain inflation news (Baqaee, 2020). People do not like inflation (Shiller, 1997), and they tend to notice or take seriously increases in its rate more than decreases.…”