Asymmetric loss and the rationality of consumers’ inflation forecasts: evidence from the US

ABSTRACT

This study investigates asymmetric loss functions for 12-month-ahead inflation forecasts by consumers in the Survey of Consumer Expectations by the Federal Reserve Bank of New York. This study finds that older households are likely to produce higher inflation forecasts. Households with highest income and educational levels are likely to produce lower inflation forecasts. In contrast, households in various regions produce similar inflation forecasts. Further, inflation forecasts are generally over-predicted even they are evaluated against the regional inflation. These expectations are broadly rational with respect to households’ prospects of their earnings, income, and unemployment, and economy-wide stock prices and unemployment under asymmetric loss. However, they are not likely to be rational with respect to the past performances of inflation and their forecasts, and regional unemployment. The results suggest that demographic characteristics play an important role in expectations formation and macroeconomic consequences. These indicate that consumers are forward-looking that is consistent with standard macroeconomic models. However, difference in regional inflation is likely to play a minor role.

KEYWORDS:

• Consumer survey
• inflation expectations
• asymmetric loss
• demographics

JEL CLASSIFICATION:

• D84
• E31
• J11

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ Specifically, Consumer Price Index for All Urban Consumers is used. Note that as a measure of inflation, the Personal Consumption Expenditure (PCE) deflator is often used. However, the PCE deflator is smaller than the inflation expectations during the sample period. This enables one to apply the method described below.

² Instrument variables are those that correspond to the demographic characteristics and regions of the inflation expectations. The same remark also applies to the rest of the models.

³ Although unreported, results under quad-quad loss function provide consistent results.