DP12906 Asymmetric Inflation Expectations, Downward Rigidity of Wages, and Asymmetric Business Cycles

Author(s): David Rezza Baqaee
Publication Date: May 2018
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JEL(s):
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12906

This paper shows that household expectations of the inflation rate are more responsive to inflationary news than to disinflationary news. This asymmetry in inflation expectations can be a source of downward nominal wage rigidity, since workers expectations adjust more quickly to inflationary shocks than disinflationary shocks. I embed asymmetric beliefs into a general equilibrium model and show that, in such a model, monetary policy has asymmetric effects on employment, output, and wage inflation consistent with the data. I microfound asymmetric household expectations using ambiguity-aversion: households, who do not know the quality of their information, overweight inflationary news since it reduces their purchasing power, and underweight deflationary news since it increases their purchasing power. Although wages are downwardly rigid in this environment, monetary policy need not have a bias towards using inflation to grease the wheels of the labor market.