Imperfect Macroeconomic Expectations: Evidence and Theory

You may be able to download this chapter for free via the Document Object Identifier.

We document a new fact about survey expectations: in response to the main shocks driving the business cycle, expectations of unemployment and inflation underreact initially but overshoot later on. We show how previous, seemingly conflicting, evidence can be understood as different facets of this fact. We finally explain what the cumulated evidence means for macroeconomic theory. There is little support for theories emphasizing underextrapolation or two close cousins of it, cognitive discounting and level-K thinking. Instead, the evidence favors the combination of dispersed, noisy information and over-extrapolation.