Food Prices, Expectations, and Inflation

Abstract

AbstractThis paper explores a hypothesis about the formation of inflation expectations, popular among policy makers, which states that economic agents place a greater weight on the recent behavior of food prices when forming expectations than expenditure shares would indicate. This hypothesis is termed the biased expectations hypothesis (BEH). Using a stochastic fixprice‐flexprice model of the U.S. economy, I derive the implications of the BEH for the overall rate of inflation and demonstrate that a bias in the formation of expectations may be Muth‐rational. The empirical results suggest that there is no bias in the formation of expectations of any consequence for policy.