Working Papers

Inflation Expectations and Consumption in the New Keynesian Framework:
The Role of Heterogeneity

(Very) preliminary WP draft

I disentangle assumptions behind the consumption response to changes in inflation expectations in the New Keynesian framework under the effective lower bound (ELB) situation. The standard result of a positive reaction hinges upon implausibly large general equilibrium effects and weak negative real expected income channel even if changes in inflation expectations are not accompanied by similar nominal wage growth expectations. I decompose the total consumption reaction into the intertemporal substitution effect and the income effect in the absence of propagation of inflation expectations into expectations of nominal salaries and show that the consumption response always stays positive in the RANK model due to the profits income channel. However, the total effect can be negative in a stylized HANK model if the lack of propagation is strong. I compute the passthrough of inflation expectations into expected nominal wages that returns a positive consumption response in the HANK case. I also discuss the role of cognitive discounting.

Presented: Directorate General Research (European Central Bank Seminar, Frankfurt), 28th International Conference on Macroeconomic Analysis and International Finance (University of Crete; Crete), 6th Behavioral Macroeconomics Workshop (Heidelberg University and Bamberg University; Heidelberg), ERMAS 2024 (Babeș-Bolyai University and National Bank of Romania; Cluj-Napoca), 4th Sailing Macro Workshop (Sapienza University of Rome; Ortygia, Siracusa), 3rd Naples School of Economics PhD and Post-Doctoral Workshop (NSE; Naples)

Average Inflation Targeting: How far to look into the past and the future?

with Jan Zemlicka

WP latest draft; ECB WP; NBS WP

We analyze the optimal window length in the average inflation targeting rule within a Behavioral THANK model. The central bank faces an occasionally binding effective lower bound (ELB) or persistent supply shocks, and can also use quantitative easing. We show that the optimal averaging period is infinitely long given a conventional degree of myopia. Finite yet long-lasting windows dominate for higher cognitive discounting; i.e., the makeup property is shown to be qualitatively resistant to deviation from rational expectations. We point out that the optimal window may depend on the speed of return to the target path. We solve the model both locally and globally to disentangle the effects of uncertainty due to the ELB. The welfare loss difference between solution techniques is considerably decreasing in the degree of history dependence.

Presented: Fall 2022 Midwest Macroeconomics Conference (Southern Methodist University; Dallas), ERMAS 2023 (University of Bucharest and National Bank of Romania; Bucharest), 2023 Expectations in Dynamic Macroeconomic Models Conference (Vienna University of Technology and Austrian National Bank; Vienna), Barcelona Ph.D. Workshop on Expectations in Macroeconomics (Barcelona School of Economics; Barcelona), 2nd Ventotene Workshop in Macroeconomics (Sapienza University of Rome; Ventotene), SASCA Ph.D. Conference in Economics (Ca’ Foscari University of Venice and University of Sassari; Venice).