Inflation Disagreement Weakens the Power of Monetary Policy

Ding Dong (), Zheng Liu, Pengfei Wang () and Min Wei

No 2024-094, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We present empirical evidence that household inflation disagreement weakens the power of forward guidance and conventional monetary policy shocks. The attenuation effect is stronger when inflation forecasts are positively skewed and it is not driven by endogenous responses of inflation disagreement to contemporaneous shocks. These empirical observations can be rationalized by a model featuring heterogeneous beliefs about the central banks' inflation target. An agent who perceives higher future inflation also perceives a lower real interest rate and thus borrows more to finance consumption, subject to borrowing constraints. Higher inflation disagreement would lead to a larger share of borrowing-constrained agents, resulting in more sluggish responses of aggregate consumption to changes in current and expected future interest rates. This mechanism also provides a microeconomic foundation for Euler equation discounting that helps resolve the forward guidance puzzle.

Keywords: Inflation disagreement; Inflation expectations; Heterogeneous beliefs; Borrowing constraints; Monetary policy transmission; Forward guidance puzzle (search for similar items in EconPapers)
JEL-codes: E21 E31 E52 E71 (search for similar items in EconPapers)
Pages: 63 p.
Date: 2024-12-06
References: Add references at CitEc
Citations:

Downloads: (external link)
https://www.federalreserve.gov/econres/feds/files/2024094pap.pdf (application/pdf)

Related works:
Working Paper: Inflation Disagreement Weakens the Power of Monetary Policy (2024)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2024-94

DOI: 10.17016/FEDS.2024.094

Access Statistics for this paper

More papers in Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.) Contact information at EDIRC.
Bibliographic data for series maintained by Ryan Wolfslayer ; Keisha Fournillier ().