Rupal Kamdar

This paper studies optimal monetary policy under rational inattention: the policy maker optimally chooses her information subject to a processing constraint. Our analytical results emphasize how the policy maker's information choices shape her expectations and the dynamics of the macroeconomy. Paying attention to demand shocks lowers output volatility and causes untracked supply shocks to drive inflation. Because persistent supply shocks have a minor impact on interest rates under full information in the New Keynesian model, the policy maker should bias her limited attention towards demand shocks. Improvements in information can explain a declining slope of the empirical Phillips curve. 

This paper provides historical context for the relationship between expected and realized inflation. We begin with a discussion of early theoretical thought about how inflation expectations are formed. Then, we discuss survey- and asset-based measures of inflation expectations and assess their empirical relationship with realized inflation. Expected and realized inflation are strongly correlated over long samples, but over short samples the correlations can weaken. Lastly, to better understand the subtleties of the interaction between expected and realized inflation over short-lived but important events, we provide a narrative account of the relationship during the Great Depression of the 1930s, the Great Inflation of the 1970s, the Great Recession of 2008-9, and the recent COVID-19 pandemic. These episodes offer compelling evidence of the importance of expectations and policy regime changes in inflation dynamics.

This paper argues for a careful (re)consideration of the expectations formation process and a more systematic inclusion of real-time expectations through survey data in macroeconomic analyses. While the rational expectations revolution has allowed for great leaps in macroeconomic modeling, the surveyed empirical micro-evidence appears increasingly at odds with the full-information rational expectation assumption. We explore models of expectation formation that can potentially explain why and how survey data deviate from full-information rational expectations. Using the New Keynesian Phillips curve as an extensive case study, we demonstrate how incorporating survey data on inflation expectations can address a number of otherwise puzzling shortcomings that arise under the assumption of full-information rational expectations. 

Using survey data, we show that consumers' economic beliefs are driven by one component, which observationally behaves like "sentiment." Surprisingly, "optimistic" consumers expecting an expansion also predict disinflation, contrasting with professional forecasts. We explain these facts in a New Keynesian model where rationally inattentive consumers face fundamental uncertainty regarding aggregate demand and supply shocks. Optimal information-gathering economizes on information costs but compresses the dimensionality of consumer beliefs. Moreover, because supply-driven recessions are more costly for typical households relying on labor income, more attention is optimally devoted to supply shocks. Inflation is hence perceived as countercyclical; the apparent "sentiment" factor structure of beliefs reflects consumers' optimal focus on aggregate supply shocks. Business cycle dynamics depend crucially on the evolution of aggregate belief misperceptions. Finally, policies which aim to stimulate the economy by raising inflation expectations can have counterproductive consequences.

This paper replaces "The Inattentive Consumer: Sentiment and Expectations".

U.S. monetary-policy decisions are made by the 12 voting members of the Federal Open Market Committee (FOMC). Seven of these members, coming from the Federal Reserve Board of Governors, inherently represent national-level interests. The remaining five members, a rotating group of presidents from the 12 Federal Reserve districts, come instead from sub-national jurisdictions. Does this structure have relevant implications for the monetary policy-making process? In this paper, we first build a panel dataset on economic activity across Fed districts. We then provide evidence that regional economic conditions influence the voting behavior of district presidents. Specifically, a regional unemployment rate that is one percentage point higher than the U.S. level is associated with an approximately nine percentage points higher probability of dissenting in favor of looser policy at the FOMC. This result is statistically significant, robust to different specifications, and indicates that the regional component in the structure of the FOMC could matter for monetary policy.

We disentangle the economic channels through which inflation expectations, over short and long horizons, affect households’ spending on durable and non-durable goods. To do so, we design a survey instrument featuring hypothetical scenarios that generate a controlled change in inflation expectations. We elicit spending decisions before and after the change and ask mechanism-elicitation questions to explore respondents’ reasoning. For most households (74%), spending is unresponsive to increased inflation expectations, typically due to fixed budget plans or irrelevance of inflation expectations for current spending. About 20% of households reduce spending, often because of saver’s wealth effects and nominal income rigidity. Only 6% of households increase their spending, mainly citing intertemporal substitution or stockpiling. Respondents whose expectations about other economic variables deteriorate following higher inflation expectations are significantly more likely to reduce their planned spending. Our findings suggest manipulating inflation expectations is an ineffective policy tool to boost spending.

This paper argues that political affiliation plays a central role in shaping household expectations and consumption behavior. Using survey and consumption data of U.S. households, we document five facts. First, household beliefs are well-described by a single factor "sentiment" model, with nearly identical factor structures regardless of political affiliation. Second, sentiment is highly persistent, with one exception: following changes in the White House, "optimists" become "pessimists" (and vice versa). Third, wide cross-sectional dispersion in sentiment is increasingly driven by political affiliation and subjectively justified by partisan narratives. Fourth, consumption responds differentially along party lines following changes in the White House. Fifth, equity prices of companies with distinct partisan consumer bases also react differentially.

Surveys consistently show large heterogeneity of macroeconomic beliefs across consumers. However, very little empirical work has been done to measure higher-order beliefs. Moreover, existing studies find that agents' own and higher-order beliefs are nearly identical. In this paper, we conduct a novel survey soliciting inflation and unemployment forecasts of US consumers. Crucially, we ask respondents to report higher-order beliefs specifically of different politically affiliated consumers (Republican, Democrat, or Independent). In this context, we find that higher-order beliefs differ substantially from own beliefs. Quantitatively, consumers correctly understand the "partisan gap" in inflation and unemployment forecasts. Providing consumers information from partisan news sources tends to move higher-order beliefs of consumers of the opposite partisan affiliation. Our results suggest that "group identity" is an important driver of own and higher-order beliefs, and provide a puzzle for noisy information models.

We develop a general equilibrium model featuring heterogeneous households, nominal rigidities, and limits to arbitrage due to segmentation in long-term bond markets. While conventional policy alone can stabilize aggregate fluctuations, the presence of market segmentation implies that such a policy leads to excessively volatile term premia in long-term yields, imperfect risk sharing, consumption dispersion, and welfare losses. When the central bank has access to balance sheet tools, we derive a separation principle for optimal policy: conventional policy stabilizes the output gap while balance sheet policy stabilizes term premia. Only when the short rate is constrained should balance sheet policy be used for macroeconomic stabilization, but this comes at the cost of imperfect financial stabilization. Thus, optimal policy may appear, at times, to be working against itself; our model implies that in the current period of high inflation, some central banks may wish to hike policy rates more aggressively while simultaneously expanding the balance sheet.

This paper investigates the causes and consequences of “supply-side beliefs” –  the tendency for households to overweight the importance of aggregate supply shocks relative to demand-side factors. We develop a New Keynesian model where agents receive news about future supply and demand shocks. Because supply shocks are more costly, potential model misspecification causes agents to endogenously downweight the likelihood that news is informative about demand shocks. The model rationalizes a number of empirical puzzles, such as the observed positive correlation between survey-based inflation and unemployment expectations, and the instability of estimated Phillips curve slope coefficients. Next, we empirically test a key prediction of the model: news shocks cause realized inflation and unemployment to move in the same direction. Using daily survey-based inflation expectations around CPI releases, we construct a novel measure of news-driven inflation expectation shocks. Consistent with the model, following an increase in our inflation expectation measure, both realized inflation and unemployment rise. These results are robust across a wide range of specifications and sample periods; quantitatively, we find that a one percentage point shock to inflation expectations boosts inflation by roughly 0.1% and unemployment by 0.2% over the next 2 years.

In the COVID-19 era, as inflation rose, the inflation expectations of Democrats remained strongly anchored, while those of Republicans did not. We document how media coverage contributed to sustained differences in beliefs about inflation, resulting in a divergence in anchoring by party affiliation. These two groups of consumers therefore face the same economic conditions and monetary policy, but have different expectations about inflation. We construct an instrument for inflation expectations using differences in partisan composition by region and use this to estimate the causal effect of inflation expectations on inflation.