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The Formation of Expectations, Inflation and the Phillips Curve

Olivier Coibion, Yuriy Gorodnichenko, Rupal Kamdar

NBER Working Paper No. 23304
Issued in March 2017, Revised in November 2017
NBER Program(s):Economic Fluctuations and Growth, International Finance and Macroeconomics, Monetary Economics

This paper argues for a careful (re)consideration of the expectations formation process and a more systematic inclusion of real-time expectations through survey data in macroeconomic analyses. While the rational expectations revolution has allowed for great leaps in macroeconomic modeling, the surveyed empirical micro-evidence appears increasingly at odds with the full-information rational expectation assumption. We explore models of expectation formation that can potentially explain why and how survey data deviate from full-information rational expectations. Using the New Keynesian Phillips curve as an extensive case study, we demonstrate how incorporating survey data on inflation expectations can address a number of otherwise puzzling shortcomings that arise under the assumption of full-information rational expectations.

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Document Object Identifier (DOI): 10.3386/w23304

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