Inflation expectations formation in the presence of policy shifts and structural breaks: An experimental analysis

Abstract

In this paper we study how in ‡ation expectations are formed and whether these change due to the occurrence of policy shifts or structural breaks. We conduct 4 experiments with 75 inexperienced subjects, in which we ask them to predict future home in ‡ation and report con…dence intervals. At three points in time during our experiments, we also ask our participants to provide additional information regarding the uncertainty about their expectations. Our design allowed us to gather 6750 home in ‡ation point forecasts and con…dence intervals. We …nd that: (1) in ‡ation expectations are seldom rational; (2) our subjects generally ignore valuable information and, instead, tend to pay close attention to past trends; (3) the adoption of in ‡ation targeting increases the amount of subjects that forecast in a rational fashion and reduces the uncertainty about future in ‡ation; and (4) a recession reduces rationality among forecasters, yet induces them to expect in ‡ation to revert to its mean.