This paper studies expectation formation of professional forecasters in the context of the Phillips curve. We assess whether professionals form their expectations regarding inflation and unemployment consistent with the Phillips curve based on individual forecast data taken from the ECB Survey of Professional Forecasters. We consider expectations over different horizons and do not restrict the analysis to point forecasts but we also take the information inherent in density forecasts into account. We explicitly consider the role of anchoring of inflation expectations as potential source of nonlinearity, and we also assess whether the Phillips curve relation translates to a link between uncertainty regarding inflation and unemployment. Our findings show that professionals tend to build their expectations in line with the Phillips curve but this is only observed for expectations made for shorter horizons. For longer horizons, the Phillips curve connection is much weaker. This relationship also depends on the degree of anchoring and results in a connection between uncertainty regarding future inflation and unemployment.

Survey respondents over-forecast inflation: they expect it to be higher than itturns out to be. Furthermore, people are generally overconfident in theirforecasts. In two experiments, we show that providing outcome feedback thatinforms people of the actual level of the inflation that they have forecastreduces both over-forecasting and overconfidence in forecasts. Theseimprovements were preserved even after feedback had been withdrawn, a findingthat indicates that they were not produced because feedback had a temporaryincentive effect but because it had a more permanent learning effect. However,providing forecasters with more outcome feedback did not have a greater effect.Feedback appears to provide people with information about biases in theirjudgments and, once they have received that information, no additional advantageis obtained by giving it to them again. Reducing over-forecasting also had noclear effect on overall error. This was because providing outcome feedback afterevery judgment also affected the noise or random error in forecasts, increasingit by a sufficient amount to cancel out the benefits provided by the reductionin over-forecasting.

The learning-from-experience model of Malmendier and Nagel [(2016) Quarterly Journal of Economics 131, 53–87] successfully reproduces the heterogeneity in inflation expectations across age groups. However, inflation expectations presumably depend on not only age and experience but also inflation regime. Therefore, this paper proposes an extended learning-from-experience model, in which expectation formation depends on inflation regime. Estimating the model with US data, I find that when inflation is higher and more volatile, households place more weight on recent data when making private forecasts. Moreover, in this regime, households rely more heavily on private forecasts than on public information.

Monthly disaggregated US data from 1978 to 2016 reveal that exposure to news on inflation and monetary policy helps to explain inflation expectations. This remains true when controlling for household personal characteristics, perceptions of government policy effectiveness, expectations of future interest and unemployment rates, and sentiment. We find an asymmetric impact of news on inflation and monetary policy after 1983, with news on rising inflation and easier monetary policy having a stronger effect in comparison to news on lowering inflation and tightening monetary policy. Our results indicate the impact on inflation expectations of monetary policy news manifested through consumer sentiment during the lower bound period.

This paper introduces structural VAR analysis as a tool for investigating the anchoring of inflation expectations. We show that US consumers' inflation expectations are anchored in the long run because macro-news shocks are long-run neutral for long-term inflation expectations. The identification of structural shocks helps to explain why inflation expectations deviate from the central bank's target. Our results indicate that the recent decline in long-term inflation expectations does not result from deanchoring macro-news but can be attributed to downward adjustments in consumers' expectations about the central bank's inflation target.

Using laboratory experiments within a New Keynesian framework, we explore the interaction between the formation of inflation expectations and monetary policy design. The central question in this paper is how to design monetary policy when expectations formation is not perfectly rational. Instrumental rules that use actual rather than forecasted inflation produce lower inflation variability and reduce expectational cycles. A forward-looking Taylor rule where a reaction coefficient equals 4 produces lower inflation variability than rules with reaction coefficients of 1.5 and 1.35. Inflation variability produced with the latter two rules is not significantly different. Moreover, the forecasting rules chosen by subjects appear to vary systematically with the policy regime, with destabilizing mechanisms chosen more often when inflation control is weaker.

We use laboratory experiments with human subjects to test the relevance of different inflation-targeting regimes. In particular and within the standard New Keynesian model, we evaluate to what extent communication of the inflation target is relevant to the success of inflation targeting. We find that if the central bank cares only about inflation stabilization, announcing the inflation target does not make a difference in terms of macroeconomic performance compared with a standard active monetary policy. However, if the central bank also cares about the stabilization of economic activity, communicating the target helps to reduce the volatility of inflation, interest rate, and output gap, although their average levels are not affected. This finding is consistent with the theoretical literature and provides a rationale for the adoption of a flexible inflation-targeting regime.

This paper derives a time-varying model to examine the dynamic interdependencies between realized and expected inflation. The results show inflation expectations at the short and long horizon have been uncorrelated over the past three decades, which is consistent with the anchored inflation expectations hypothesis. There is also little evidence that changes in realized inflation have been the result of self-fulfilling variations in the expectations of economic agents. Despite high commodity prices and above-trend inflation, expectations since the financial crisis in 2008 have not become unhinged from fundamentals.