2015 Series • No. 15–5
Research Department Working Papers
Expectations as a Source of Macroeconomic Persistence: An Exploration of Firms' and Households' Expectation Formation 
While there is little question that expectations lie at the heart of much economic decision-making, and therefore at the heart of models of the macroeconomy that hope to reflect such decision-making, how such expectations are formed is an open research question. In earlier work, Fuhrer (2015) showed that empirical estimates of a standard dynamic stochastic general equilibrium (DSGE) model preferred inertia in expectations over price indexation or habit formation as a mechanism to explain the persistence of aggregate time series for output, inflation, and interest rates. A question left open in that paper was why and how expectations might exhibit such inertia. This paper examines the expectations behavior of individual responses in the surveys of the Survey of Professional Forecasters (SPF) and the University of Michigan's Survey Research Center to shed light on that question.
Key Findings
- Respondents to the surveys of the SPF and the University of Michigan's Survey Research Center consistently revise their forecasts of inflation, unemployment, and other key variables so as to move them closer to the lagged central tendency of expectations in the survey. This result is quantitatively and statistically significant, and is robust to the inclusion of essentially all of the real-time information available in these surveys.
- The paper shows that rational agents with full information have no motive to link their current forecast to lagged central tendencies.
Implications
The findings suggest that economic agents who do not know the true structure of the economy anchor their forecasts to the most recently observed median forecast, which, on average, will contain important aggregated information about the variables they are attempting to forecast. Building such expectations into relatively standard (but admittedly simple) macroeconomic models can generate the kinds of impulse responses that are commonly found in macroeconomic vector autoregressions, without resorting to the bells and whistles that have been added to DSGE models in recent years.
Although the micro data results appear quite robust, their implications for macroeconomic dynamics merit further investigation. However, coupled with the results in Fuhrer (2015), this paper suggests that micro data-based expectations behavior in which agents "look over their shoulders," using lagged aggregate expectations as an anchor for their individual expectations, might go far in explaining the persistence observed in macro data.
Abstract
This paper examines the expectations behavior of individual responses in the surveys of the Survey of Professional Forecasters and the University of Michigan's Survey Research Center. The paper finds that respondents consistently revise their forecasts of inflation, unemployment, and other key variables so as to move them closer to the lagged central tendency of expectations in the survey. This result is quantitatively and statistically significant, and is robust to the inclusion of essentially all of the real-time information available in these surveys. The paper shows that rational agents with full information have no motive to link their current forecast to lagged central tendencies. This may suggest that economic agents who do not know the true structure of the economy utilize a simple solution to a filtering problem, anchoring their forecasts to the most recently observed median forecast, which on average will contain important aggregated information about the variables they are attempting to forecast. This regularity bears important implications for macroeconomic dynamics, as illustrated in the last section of the paper. The regularity also provides a micro-based foundation for an earlier paper's finding that expectations persistence is an important source of the macroeconomic persistence (Fuhrer 2015).