We study how people's beliefs about the economy covary with household-level events, utilizing a unique link between Danish administrative data and a large-scale survey of consumer expectations. We find that compared to actual inflation, people's inflation forecasts covary much more strongly (and negatively) with both recently realized household income changes and measures of expected future household income changes. We formally establish that these findings are stark deviations from the Bayesian limited-information rational expectations (LIRE) benchmark. Similar results hold for perceptions of past inflation ("backcasts"), suggesting that imperfect recall is a key mechanism for biased forecasts. Building on this, a series of additional tests, some of which utilize data on adverse health events, suggests that the forecast biases are at least partly due to selective recall cued by affective associations. That is, negative (positive) household-level events cue negative (positive) recollections, which lead to pessimistic (optimistic) forecasts.
Authors
- Acknowledgements & Disclosure
- For helpful comments and suggestions, we thank Hassan Afrouzi, George-Marios Angeletos, Nick Barberis, Andrew Caplin, Lawrence Christiano, Olivier Coibion, Francesca Bastianello, Stefano DellaVigna, Joel Flynn, Yuriy Gorodnichenko, Martin Eichenbaum, Joao Guerreiro, Joe Hazell, Kilian Huber, Cosmin Ilut, Alex Imas, Supreet Kaur, Spencer Kwon, Eben Lazarus, Yueran Ma, Pooya Molavi, Emi Nakamura, Ricardo Perez-Truglia, Pontus Rendahl, Frederic Robert-Nicoud, Christopher Roth, Karthik Sastry, Martin Schneider, Benjamin Schoefer, Na'ama Shenhav, Andrei Shleifer, Jason Somerville, Johannes Stroebel, Jon Steinsson, Aleksey Tetenov, Mike Woodford, and seminar participants at Columbia, Federal Reserve Bank of Boston, Federal Reserve Bank of Chicago, Northwestern, Society for Economic Dynamics, Stanford, Stony Brook Workshop on Learning and Bounded Rationality, UC Berkeley, and UT Austin. We thank the Independent Research Fund Denmark (DFF) for financial support (Sapere Aude Starting Grant n.: 1053-00013B). Matteo Saccarola gracefully acknowledges support from the NBER fellowship in Behavioral Macroeconomics. We are grateful to Sophie Dewees, Chenxi Jiang, and Anders Yding for excellent research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
- DOI
- https://doi.org/10.3386/w32664
- Pages
- 102
- Published in
- United States of America
Table of Contents
- Data, Sample Selection, and Variable Construction 7
- Survey Data 7
- Administrative Registry Data 9
- Sample Construction 10
- Template for Analysis 12
- Inflation Forecasts and Recent Changes in Household Income 15
- Testing LIRE Using Variables in People's Information Sets 15
- Main Empirical Results 17
- Additional Results and Robustness 18
- Inflation Forecasts and Expected Future Household Income Changes 20
- Forecastability of Future Income Changes 21
- Inflation Forecasts and Forecasted Household Financial Situation Changes 21
- Formal Test 21
- Implementation and the Main Result 22
- Inflation Forecasts and Realized Future Changes in Household Income 23
- Formal Test 24
- Implementation and Main Result 25
- Additional Results and Robustness 26
- Extensions and Mechanisms 26
- Inflation Backcasts Predict Forecast Errors 26
- Inflation Backcasts and Changes in Household Income 27
- Affective Association 28
- Conclusion 30
- References 32
- Online Appendix 52
- Data Appendix 52
- Registries Used and Documentation 52
- Survey data 52
- Emergency Room Visits Data 53
- Final Datasets 54
- A Note on Empirical Cumulative Distribution of Continuous Variables 55
- Data Citations 56
- Non response and sample restrictions 57
- Survey Questions 57
- Supplementary Empirical Results 62
- Summary Statistics and Representativeness of Survey Respondents 62
- Demographic Correlates of Inflation Forecasts 65
- Auxiliary Results to Section 3 66
- Inflation Forecasts and Placebo Income Changes 66
- Additional Results for Recent Labor Income Changes 67
- Recent Wealth Changes 68
- Recent Income Change: Years 2008 to 2019 69
- Recent Income Change: Real Income Changes 70
- Auxiliary Results to Section 4 71
- Forecastability of Future Income Changes 71
- Inflation Forecast, Forecasted Family Finance Changes and Future Income Changes: Sub-sample analysis 72
- Inflation Forecast and Future Labor Income Changes 74
- Results from Michigan Survey of Consumers: Inflation Forecasts and Expected Future Changes in Household Income 75
- Forecastability of Income, Inflation Forecast and Future Income Changes: Real Income Changes 77
- Forecastability of Income, Inflation Forecast and Future Income Changes: Years 2008 to 2019 80
- Auxiliary Results to Section 5 83
- Inflation Backcasts Correlate with Forecast Errors and Inflation Forecasts Correlate with Inflation Backcast Errors 83
- Inflation Backcasts: Subsample Analysis for Recent Income changes, Forecasted Family Finances Changes, and Future Income Changes 83
- Inflation Backcasts: Labor Income Analysis for Recent Income Changes and Future Income Changes 87
- Additional Results to Section 5.3 89
- Additional Results to Section 5.4 90
- Mathematical Results 97
- Proofs 97
- Processes Satisfying Assumption 4 99
- An additional bound for Test 3. 101
