Working Paper: NBER ID: w20161
Authors: Kinda Hachem; Jing Cynthia Wu
Abstract: We propose a new framework for understanding the effectiveness of central bank announcements when firms have heterogeneous inflation expectations. Expectations are updated through social dynamics and, with heterogeneity, not all firms choose to operate, putting downward pressure on realized inflation. Our model rationalizes why countries stuck at the zero lower bound have had a hard time increasing inflation without being aggressive. The same model also predicts that announcing an abrupt target to disinflate will cause inflation to undershoot the target whereas announcing gradual targets will not. We present new empirical evidence that corroborates this prediction.
Keywords: Inflation; Central Bank Communication; Social Dynamics
JEL Codes: E17; E3; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Central bank announcements (E52) | Firms' inflation expectations (E31) |
| Firms' inflation expectations (E31) | Pricing decisions (D49) |
| Firms' exit from the market (L19) | Inflation undershooting (E31) |
| Abrupt target announcements (E60) | Inflation undershooting (E31) |
| Gradual announcements (Y20) | Avoidance of inflation undershooting (E31) |