Short-run Expectations Research Articles

Monetary policy and the term structure of inflation expectations with information frictions

I estimate how the term structure of inflation expectations in the United States responds to monetary policy shocks from 1982 to 2019. Studying the entire term structure uses all available data and allows me to examine whether forecasts at different horizons respond differently to the same shock, which may influence bond pricing, investment decisions, and the term structures of real and nominal interest rates. Survey forecasts of inflation (taken from the Survey of Professional Forecasters) are available at many horizons, but combining these in a consistent way is challenging because of information frictions and the number of available forecasts. I extend the unobserved components model to include additional covariates and allow for information frictions, a combination of features that allows me to identify the effects of monetary policy shocks, which I do using an instrumental variable. I find that a contractionary monetary policy shock twists the term structure of inflation expectations, raising short-run expectations while lowering long-run expectations, which suggests that long-run expectations are not well anchored. I also show that monetary policy actions taken throughout the recession beginning in 2008 propped up long-run inflation expectations from 2009 to 2014.

Long-run expectations of households

The rational expectations assumption, e.g. in life-cycle models and portfolio-choice models, prescribes that all actions are in line with a well-structured and unbiased system of expectations. In reality, justification and identification of expectations are nontrivial, and we lack empirical evidence especially for the long run. This paper starts to fill this gap and elicits short-run and long-run expectations of a sample of households that is designed to be representative of the universe of German households. We focus on expectations about three highly welfare-relevant markets: the stock market, the labor market, and the housing market. We show that linear extrapolations of short-run expectations can approximate long-run expectations in the labor market, but not in financial or housing markets. In the latter two markets, long-run expectations of households are severely below linear price growth and far below historical values. This extreme pessimism does not extend to the labor market, where expectations are fairly close to historical values. We also document substantial heterogeneity of expectations by socio-economic and personal characteristics, e.g., females are more pessimistic than males about outcomes in all markets.

What Have They Been Thinking? Homebuyer Behavior in Hot and Cold Markets A 2014 Update

Questionnaire surveys undertaken in 1988 and annually from 2003 through 2014 of recent homebuyers in each of four U.S. metropolitan areas shed light on their expectations and reasons for buying during the recent housing boom and subsequent collapse. They also provide insight into the reasons for the housing crisis that initiated the current financial malaise. We find that homebuyers were generally well informed, and that their short-run expectations if anything underreacted to the year-to-year change in actual home prices. More of the root causes of the housing bubble can be seen in their long-term (10-year) home price expectations, which reached abnormally high levels relative to mortgage rates at the peak of the boom and have declined sharply since. The downward turning point, around 2005, of the long boom that preceded the crisis was associated with changing public understanding of speculative bubbles.

Keynes’s Use of Certainty Equivalent, Short Run Expectations in the General Theory, the Evidential Weight of the Argument, V(a/H)=W, 0≤w≤1, the Townshend -Keynes Exchanges of 1937–38, and Is-Lm: Rational Expectations Was a Special Case for Keynes if W=1 for Long Run Expectations

The failure of all economists and philosophers in the 20th and 21st centuries to grasp the formal, technical analysis of the 'weight of the arguments' analysis in chapters 6 and 26 of Keynes’s A Treatise on Probability explains why the footnotes on pages 148 and 240 of the General Theory, the importance of which Keynes emphasized to Townshend in 1938, at the exact same time that Keynes was also engaged in a severe critique of Tinbergen’s misapplication of the limiting frequency interpretation of probability to business cycles using a multivariate normal probability distribution, have never been incorporated into Keynes’s theory of effective demand, the D-Z model, which served as the foundation for Keynes’s IS-LM(LP) model on pp .298-299 in Part IV of chapter 21 of the General Theory. Keynes’s certainty equivalence for the expectations embodied in Z=wN +P and D=pO incorporated expectations as a function of uncertainty, where uncertainty is a function of the evidential weight of the argument, w, which ranges from complete knowledge, w=1 to complete ignorance, w=0. This is very similar to A. Greenspan’s 2004 paper in the AER that specified a Continuum that ranged from complete ignorance to complete knowledge. The certainty equivalences for the P variable, expected profits, and the p variable, expected prices, were formalized directly from Keynes’s conventional coefficient,c. Y, realized aggregate income, is a function of the expectational D-Z locus, called by Keynes the aggregate supply curve (ASC). Once a particular Y value is specified, Keynes combined it with the long run nominal rate of interest, r, to specify the IS-LM(LP) model in (Y,r) space. Keynes showed that a severe problem of absolute liquidity preference would show up once the long run nominal rate reached 2% due to lack of confidence and fear of the future. Monetary policy would fail, leaving some type of fiscal policy as the only possible policy alternative in a severe recession or depression. In response to Townshend’s 1937-1938 pleas for guidance concerning the connection between Keynes’s theory of liquidity preference and the A Treatise on Probability’s logical theory of probability Keynes simply reiterated that Townshend needed to reread pages 148 and 240 of the General Theory, given Townshend’s own statement that he had read the A Treatise on Probability. The answer that Townshend never found appears on page 315 of the A Treatise on Probability in chapter 26, which is the mathematical complement and supplement to the initial logical treatment of the V relation provided by Keynes in chapter 6. Only in chapter 26 does Keynes make it clear that V(a/h)=w,0≤w≤1.

Is Fertility a Leading Economic Indicator?

Abstract Many papers show that aggregate fertility is pro-cyclical over the business cycle. Using data on more than 100 million births from 1988 to 2014, we show that for recent recessions in the United States, there is a large and rapid fall in the growth rate of conceptions several quarters prior to economic decline. This newly emerging pattern appears in the aggregate data, as well as within individual states and in many European countries. Our findings suggest that fertility behaviour is more forward looking and sensitive to changes in short-run expectations about the economy than previously thought.

Can Shiozawa’s, Morioka’s and Taniuchi’s Microfoundations for Evolutionary Economics (2019) Serve As the Microfoundations for “… Post-Keynesian Economics “ (2019, p.vii)? The Answer Is Definitely Yes if Post –Keynesians Can Break Away From Joan Robinson’s Anti-Mathematical, Anti-Formalist Views

Can Shiozawa’s, Morioka’s and Taniuchi’s Microfoundations for Evolutionary Economics (2019) Serve As the Microfoundations for “… Post-Keynesian Economics “ (2019, p.vii)? The Answer Is Definitely Yes if Post –Keynesians Can Break Away From Joan Robinson’s Anti-Mathematical, Anti-Formalist Views

The term structure of cross-sectional dispersion of expectations in a Learning-to-Forecast Experiment

In this paper, we present the results of a Learning-to-Forecast Experiment (LtFE) where we eliciting short- as well as long-run expectations regarding the future price dynamics in markets with positive and negative expectations feedback. Comparing our results on short-run expectations with the LtFE literature, we prove that eliciting long-run expectations has no impact on the price dynamics nor on short-run expectations formation. In particular, we confirm that the Rational Expectation Equilibrium (REE) is a good benchmark only for the markets with negative feedback. Interestingly, our data show that while the term structure of the cross-sectional dispersion of expectations is convex in positive feedback markets, it is concave in negative feedback markets. Differences in the slope of the term structure stem from diverse degrees of uncertainty regarding the evolution of prices in the two feedback systems: (1) in the negative feedback system, the convergence of the price to the REE reflects a tendency for coordination of long-run expectations around the fundamental value; (2) conversely, oscillatory price dynamics observed in the positive feedback system is responsible for the diverging pattern of long-run expectations. Finally, we propose a new measure of heterogeneity of expectations based on the scaling of the dispersion of expectations over the forecasting horizon.

The Short-Run Effect of Monetary Policy Shocks on Credit Risk: An Analysis of the Euro Area

We examine the credit channel of monetary policy from 2000 to 2015 in the Euro Area using daily monetary policy shock and credit risk measures in an autoregressive distributed lag model. We find that an expansionary monetary policy shock leads to a short-run increase in the credit risk of non-financial corporations. This dysfunctionality of the credit channel is driven by the crisis-dominated post-2009 period. During this period, market participants may have interpreted expansionary monetary policy shocks as a signal of worsening economic prospects. We further distinguish policy shocks aiming at short- and long-run expectations of market participants, i.e. target and path shocks. The adverse effect disappears for crisis countries when the European Central Bank targets long-run rather than short-run expectations.

Long-run expectations in a learning-to-forecast experiment: a simulation approach

In this paper, we elicit short-run as well as long-run expectations on the evolution of the price of a financial asset in a Learning-to-Forecast Experiment (LtFE). Subjects, in each period, have to forecast the the asset price for each one of the remaining periods. The aim of this paper is twofold: first, we fill the gap in the experimental literature of LtFEs where great effort has been devoted to investigate short-run expectations, i.e. one step-ahead predictions, while there are no contributions that elicit long-run expectations. Second, we propose a new computational algorithm to replicate the main properties of short and long-run expectations observed in the experiment. This learning algorithm, called Exploration-Exploitation Algorithm, is based on the idea that agents anchor their expectations around the last realized price rather than on the fundamental value, with a range proportional to the past observed price volatility. When compared to the Heuristic Switching Model, our algorithm performs equally well in describing the dynamics of short-run expectations and the realized price dynamics. The EEA, additionally, is able to reproduce the dynamics long-run expectations.

New evidence on the evolution of the anchoring of inflation expectations

We investigate the degree of anchoring in inflation expectations for different advanced economies using data from professional forecasters’ surveys. We define expectations as anchored when movements in short-run expectations do not trigger movements in expectations at longer horizons. Using time-varying parameter regressions, we provide evidence that anchoring has varied noticeably across economies and over time. In particular, we find that after the financial crisis expectations have been firmly anchored at the target in the United States and, to a lesser extent, in the United Kingdom. In the euro area, expectations have been de-anchored shortly after the crisis and again starting from 2014. In Japan de-anchoring is more pervasive all over the sample period.

Is Fertility a Leading Economic Indicator?

Many papers show that aggregate fertility is pro-cyclical over the business cycle. In this paper we do something else: using data on more than 100 million births and focusing on within-year changes in fertility, we show that for recent recessions in the United States, the growth rate for conceptions begins to fall several quarters prior to economic decline. Our findings suggest that fertility behavior is more forward-looking and sensitive to changes in short-run expectations about the economy than previously thought.

Long-run expectations in a learning-to-forecast experiment

ABSTRACTWe conduct a Learning to Forecast Experiment using a novel setting in which we elicit subjects’ short- and long-run expectations on the future price of an asset. We find that: (i) the rational expectations equilibrium is not a meaningful description for the whole time spectrum of subjects’ expectations; (ii) they are, instead, better described by an anchor-and-adjustment learning scheme; (iii) subjects exhibit a higher degree of heterogeneity in their long-run expectations vis-à-vis short-run expectations.

Great expectations? evidence from Colombia’s exchange rate survey

In this paper, we use the largest exchange rate survey in Colombia to test for the rational expectations hypothesis, the presence of a time-varying risk premium and the accuracy of exchange rate forecasts. Our findings indicate that episodes of exchange rate appreciation preceded expectations of further appreciation in the short run, but were marked by depreciations in the long run. This reversal largely explains the stabilizing pattern of expectations. Additionally, we find that the forward discount differed from future exchange rate changes due to the rejection of the unbiasedness condition and to the presence of a time-varying risk premium. Finally, we find that only short run expectations were able to outperform a random walk process as well as models of extrapolative, adaptive, and regressive expectations. Long-run expectations, on the other hand, behaved poorly in terms of forecasting accuracy.

The Evolution of the Anchoring of Inflation Expectations

We investigate the degree of anchoring in inflation expectations for different advanced economies using data from professional forecasters' surveys. We define expectations as anchored when movements in short-run expectations do not trigger movements in expectations at longer horizons. Using time-varying parameter regressions, we provide evidence that anchoring has varied noticeably across economies and over time. In particular, we find that starting from the second half of 2008, inflation expectations in the euro area, unlike in the US and in the UK, have shown signs of a de-anchoring.

Lectures on John Maynard Keynes' General Theory of Employment, Interest and Money (4): Chapter 4, 'The Choice of Units'; Chapter 5, 'Expectations as Determining Output and Employment'

In Chapter 4 of the General Theory, Keynes discusses the units of measurement he will be using in the remainder of the book, in particular his reason for measuring in nominal rather than real terms, objection to aggregate measures of real output and physical capital stock, and his concept of wage units, which is a source of difficulty in following bits of the later exposition. Chapter 5 introduces expectations and discusses the role of short run expectations in determining the behavior of firms and of economic aggregates.

What Have They Been Thinking? Home Buyer Behavior in Hot and Cold Markets

Questionnaire surveys we have undertaken in 1988 and annually 2003-2012 of recent homebuyers in each of four U.S. cities shed light on their expectations and reasons for buying and selling during the recent housing boom and subsequent collapse, and on the reasons for the housing crisis that initiated the current financial malaise. We find that homebuyers were generally well informed, and that their short-run expectations if anything underreacted to the year-to-year change in actual home prices. More of the root causes of the bubble can be seen in their long-term, ten-year, home price expectations, which reached abnormal levels relative to the mortgage rate at the peak of the boom and declined sharply since. The downward turning point around 2005 of the long boom that preceded the crisis was associated with changing public understanding of speculative bubbles.

Heterogeneous expectations and debt in a growth model for a small open economy

We extend an aggregative growth model for a small open economy by developing a framework in which boundedly rational agents raise credit in proportion to their expected income. Moreover, these agents are heterogeneous in the sense that they switch between an extrapolative and a regressive forecasting rule with respect to perceived market circumstances. Using a mixture of analytical and numerical tools, we attempt to describe the characteristics of our model’s dynamical system. Our results then suggest that self-fulfilling short-run expectations do not only have important consequences for fluctuations in economic activity but are also a source of simple endogenous dynamics.

What Have They Been Thinking?: Homebuyer Behavior in Hot and Cold Markets

Questionnaire surveys undertaken in 1988 and annually from 2003 through 2012 of recent homebuyers in each of four U.S. metropolitan areas shed light on their expectations and reasons for buying during the recent housing boom and subsequent collapse. They also provide insight into the reasons for the housing crisis that initiated the current financial malaise. We find that homebuyers were generally well informed, and that their short-run expectations if anything underreacted to the year-to-year change in actual home prices. More of the root causes of the housing bubble can be seen in their long-term (10-year) home price expectations, which reached abnormally high levels relative to mortgage rates at the peak of the boom and have declined sharply since. The downward turning point, around 2005, of the long boom that preceded the crisis was associated with changing public understanding of speculative bubbles.

The Educational Expectations of Children of Immigrants in Italy

In this article, the authors investigate the short-run educational expectations and long-term educational aspirations of the children of immigrants living in Italy and attending eighth grade. The authors look at educational ambition, both as a predictor of educational choice and as a measure of social integration. They consider both secondary-school track and university goals. Data come from the ITAGEN2 survey (2005–2006). First, the authors analyze the relationship of short-run expectations and long-term aspirations to structural (e.g., migration status and country of origin) and social (e.g., family socioeconomic status and friendship ties) conditions. The latter seem to be determinants of both expectations and aspirations, but long-term educational aspirations are not associated with migration status. Second, the authors investigate the relevance of context in delineating educational attitudes. The authors performed a multilevel analysis including both individual- and school-level variables. Their results show that attending a school where most of the Italian pupils have high educational expectations may lead children of immigrants to enhance their own aspirations.

Twisting the Dollar? On the Consistency of Short-Run and Long-Run Exchange Rate Expectations

We examine consistency properties of the exchange rate expectation formation process of short-run and long-run forecasts in the dollar/euro and yen/dollar market. Applying nonlinear consistency restrictions we show that in a simple expectation formation structure short-run forecasts are indeed inconsistent with long-run predictions. Moreover, we establish a ‘twist’ in the dollar/euro expectation formation process, i.e. market participants expect bandwagon effects in the short run, while they have stabilizing expectations in their long-run forecasts. Applying a panel probit analysis we find that this twisting behavior is more likely to occur in periods of excess exchange rate volatility. Copyright © 2011 John Wiley & Sons, Ltd.