This paper examines the impact of the Federal Reserve’s communication on short-term inflation forecasts. Following the adoption of an explicit inflation target in 2012, individual forecasts in the Survey of Professional Forecasters (SPF) exhibit two key behavioral changes in their four-quarter-ahead inflation forecasts: (1) increased confidence in their beliefs and (2) less overreactive forecasts to news, aligning more closely with rational expectations. A key factor driving these behavioral shifts is the reduction in uncertainty about trend inflation. To support this claim, I propose a parsimonious inflation expectations model with smooth diagnostic expectations. Since 2012, more precise trend inflation data has given forecasters greater certainty, leading them to rely more on current news and less on the representativeness heuristic, thus reducing overreactive expectations. The model captures changes in both the first and second moments of individuals' predictive densities, providing an explanation for the decrease in short-term forecast disagreement. This decline in short-term disagreement suggests enhanced individual rationality, while the reduction in long-term disagreement can be attributed to anchoring effects.
In this study, I use a DSGE model to analyze how economic agents with rational inattention respond to varying levels of economic volatility. Specifically, I compare agent behavior across two periods: the Pre-Great Moderation (1960Q1–1983Q4), characterized by high volatility, and the Great Moderation (1984Q1–2007Q2), marked by lower volatility. I find that economic agents allocate more attention to changes in the economy during periods of high volatility, validating the rational inattention framework across different economic environments. Specifically, households and firms adjust their decisions more quickly when the economy becomes more volatile, which in turn leads to faster behavioral adjustments during the pre-Great Moderation period.