Imperfect Macroeconomic Expectations: Evidence and Theory
We document a new fact about expectations: in response to the main shocks driving the business cycle, expectations under-react initially but over-shoot 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 under-extrapolation 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.
This paper was prepared for the 2020 NBER Macroeconomics Annual. We owe special thanks to our discussants, Ricardo Reis and Jessica Watcher, and the organizers, Martin Eichenbaum and Erik Hurst. We also thank Fabrice Collard for help with some of the material in Section 5. We finally thank Jeffrey Campbell, Olivier Coibion, Nicola Gennaioli, Cosmin Ilut, Yueran Ma, and Alp Simsek for useful comments. Angeletos acknowledges the financial support of the National Science Foundation (Award #1757198). There is no other financial interest or conflict to disclose. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Forthcoming: Imperfect Macroeconomic Expectations: Evidence and Theory, George-Marios Angeletos, Zhen Huo, Karthik A. Sastry. in NBER Macroeconomics Annual 2020, volume 35, Eichenbaum and Hurst. 2020