1 Consumer Inflation Uncertainty
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UC Berkeley UC Berkeley Electronic Theses and Dissertations Title Expectations and Uncertainty in the Macroeconomy Permalink https://escholarship.org/uc/item/8755m00n Author Binder, Carola Conces Publication Date 2015 Peer reviewed|Thesis/dissertation eScholarship.org Powered by the California Digital Library University of California Expectations and Uncertainty in the Macroeconomy by Carola Conces Binder A dissertation submitted in partial satisfaction of the requirements for the degree of Doctor of Philosophy in Economics in the Graduate Division of the University of California, Berkeley Committee in charge: Professor Yuriy Gorodnichenko, Chair Professor David H. Romer Professor Shachar Kariv Professor Edward Augenblick Spring 2015 Expectations and Uncertainty in the Macroeconomy Copyright 2015 by Carola Conces Binder 1 Abstract Expectations and Uncertainty in the Macroeconomy by Carola Conces Binder Doctor of Philosophy in Economics University of California, Berkeley Professor Yuriy Gorodnichenko, Chair This dissertation consists of three chapters with a common theme of expectations and beliefs in the macroeconomy. The first chapter introduces a micro-level measure of consumer inflation uncertainty. Literature on cognition and communication documents that people use round numbers as a communicative tool to convey uncertainty. I construct an uncertainty measure that exploits consumers' tendency to round their inflation forecasts to multiples of five on the Michigan Survey of Consumers. I document cross-sectional and time series properties of the measure and provide support for its validity. Mean inflation uncertainty is countercyclical and positively correlated with inflation disagreement, inflation volatility, and the Economic Policy Uncertainty Index. Inflation uncertainty varies more in the cross section than over time, so a major benefit of this new measure is its cross-sectional dimension which enables micro-level analysis of the relationship between uncertainty and consumption. More uncertain consumers are more reluctant to spend on durables, cars, and homes, and their spending attitudes are less sensitive to interest rates. The measure also has applications to inflation dynamics and monetary policy. For example, the expectations of more-certain consumers can be used to improve Phillips curve estimation. The second chapter focuses on central bank communication with households. Transparent communication with the general public is a stated goal of the Federal Reserve. While most research has focused on central bank communication with financial markets, this paper evaluates the effectiveness of Federal Reserve communication with the public at large. While professional forecasters are attentive to Federal Reserve communications regarding the price stability objective, including the announcement of a 2% inflation target, many households are not. Consumers' inflation expectations are weakly-anchored, especially among less-educated, low-income, and female consumers. Anchoring has not improved notably since the late 1990s. News and media data reveal that Federal Reserve communications are not widely propagated through traditional or new media channels to the public and that that consumers do not proactively seek information on monetary policy. Evidence collected from dozens of surveys from the 1950s to 2014 exposes a lack of public awareness of the Federal Reserve and its objectives and a decline in public opinion of central bankers. 2 The third chapter studies expectations in an important episode of economic history. Com- peting interpretations of the Great Depression depend on the behavior of inflation expecta- tions in the onset and recovery. A number of papers have examined whether the deflation of 1930-32 was anticipated and when positive inflationary expectations reappeared. I review and compare the various statistical, narrative, and market-based approaches that have been used to estimate inflation expectations in the Great Depression era and supplement these approaches with additional methods and narrative evidence. I introduce a new approach using Phillips curve estimation. Reconciling the disparate findings of the previous literature, I conclude that the deflation was mostly unanticipated until mid-1930 and that a regime change occurred at the start of Roosevelt's presidency, prior to monetary expansion. i To Joe and Ruby ii Contents Contents ii List of Figures iv List of Tables v 1 Consumer Inflation Uncertainty 1 1.1 Introduction . 1 1.2 Round Numbers and the Expression of Uncertainty . 4 1.3 Construction of Inflation Uncertainty Proxy . 7 1.4 Properties and Validity of Uncertainty Proxy . 12 1.5 Inflation Uncertainty and Consumption . 20 1.6 Inflation Uncertainty and the Phillips Curve . 26 1.7 Long-Run Uncertainty and Expectations Anchoring . 28 1.8 Discussion and Conclusions . 31 2 Fed Speak on Main Street 33 2.1 Introduction . 33 2.2 History and Theory of Fed Communication . 36 2.3 Inflation Expectations Anchoring . 40 2.4 The Role and Use of Media . 45 2.5 Other Survey Evidence . 50 2.6 Strategies in Other Countries . 53 2.7 Discussion and Conclusions . 58 2.8 Tables and Figures . 60 3 Inflation Expectations in the Great Depression 70 3.1 Introduction . 70 3.2 Inflation Expectations in Theories of the Depression . 71 3.3 Market-Based Approaches . 77 3.4 Statistical Approaches . 83 3.5 Narrative Approaches . 90 iii 3.6 Consensus and Conclusions . 99 Bibliography 102 A Consumer Inflation Uncertainty Appendices 117 A.1 Data Descriptions . 118 A.2 Identifying Heaping with Whipple Indices . 121 A.3 Non-Normal Distributional Assumptions . 123 A.4 Disagreement and Uncertainty . 124 A.5 Model of Inflation Uncertainty and Intertemporal Allocation . 128 A.6 Inflation Uncertainty and Consumption . 129 A.7 Phillips Curve Robustness Checks . 136 B Fed Speak on Main Street Appendices 141 B.1 Summary of Consumer Surveys . 142 C Inflation Expectations in the Great Depression Appendices 151 C.1 Data Descriptions . 152 C.2 New Keynesian Monte Carlo Simulations . 152 iv List of Figures 1.1 Histograms of inflation expectations and realized inflation. 6 1.2 Maximum likelihood estimates of mixture distribution parameters . 9 1.3 Estimates of uncertainty proxy ζit ......................... 10 1.4 Inflation uncertainty index . 12 1.5 Inflation uncertainty index with related time series . 17 1.6 Inflation uncertainty and the absolute deviation of inflation from 2% . 19 1.7 Realized inflation and inflation predicted by Phillips curves . 28 1.8 Inflation uncertainty index by horizon . 30 1.9 Long-horizon inflation uncertainty before and after explicit inflation target . 30 2.1 The anchoring of consumer inflation expectations . 62 2.2 Indicators of expectations anchoring over time . 63 2.3 Characteristics of inflation forecasts by investment quintile . 63 2.4 Newspaper Coverage of Inflation and the Federal Reserve . 64 2.5 Google search volume for inflation, Federal Reserve, and interest rates . 64 2.6 Facebook post by the San Francisco Federal Reserve . 65 2.7 Percent of consumers hurt by inflation . 66 2.8 Knowledge of official inflation and unemployment rates . 67 2.9 PublicoOpinion of federal reserve chairs . 68 2.10 Confidence in central banks . 69 3.1 Macroeconomic time series 1925-38 . 72 3.2 Expected inflation estimates in the literature . 76 3.3 Stock prices and one-year-ahead CPI inflation . 79 3.4 Expected inflation estimated from Phillips curve and realized inflation . 83 3.5 Expected inflation estimated by AR(1) model . 86 3.6 Expected inflation estimated by multivariate approach . 88 A.1 Inflation uncertainty index with normal and logistic error distributions . 124 A.2 Inflation disagreement and mean inflation uncertainty by consumer type . 125 A.3 Inflation uncertainty estimates compared to Survey of Consumer Expectations . 127 A.4 Consumption by inflation uncertainty . 128 v List of Tables 1.1 Forecast errors and revisions for round and non-round forecasts. 7 1.2 Properties of inflation uncertainty proxy ζit .................... 13 1.3 Expectations and uncertainty by demographic group . 15 1.4 Inflation uncertainty ζit regressed on demographic, opinion, and news variables 16 1.5 Correlation between consumer inflation uncertainty index Ut and aggregate spend- ing series . 21 1.6 Spending attitudes, aggregate spending, and inflation uncertainty . 23 1.7 Inflation uncertainty and interest rate sensitivity . 25 1.8 Phillips Curve regressions with inflation expectations of different agent types . 27 2.1 Indicators of Expectations Anchoring Regressed on Demographic Variables. 61 3.1 Stock price approach regressions, 1924-1938. See Equation (3.3). 78 3.2 Phillips curve regressions, 1924-1938. 82 3.3 Multivariate statistical approach regressions . 89 3.4 Summary of estimated Great Depression era inflation expectations . 100 A.1 Spending attitude and aggregate expenditure variables . 119 A.2 Control variables in spending attitudes regressions . 120 A.3 Inflation forecasts and inflation realizations . 122 A.4 Maximum likelihood estimates with normal and logistic errors . 123 A.5 Spending attitudes, inflation uncertainty, and inflation expectations . 130 A.6 Marginal effects of inflation uncertainty on spending attitudes . 131 A.7 Spending attitudes, round number responses, and inflation expectations . 132 A.8 Control function approach . 133 A.9 Inflation uncertainty and the desire to buy in advance of rising prices . 134 A.10 Inflation uncertainty and the desire to buy in advance of rising prices . 135 A.11 Marginal effects of inflation uncertainty on interest rate mentions in spending attitudes . 136