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Asymmetric Inflation Expectations, Downward Rigidity of Wages and Asymmetric Business Cycles

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  • David Rezza Baqaee

    (Department of Economics, London School of Economics (LSE)
    Centre for Macroeconomics (CFM))

Abstract
Household expectations of the inflation rate are much more sensitive to inflation than to disinflation. To the extent that workers have bargaining power in wage determination, this asymmetry in their beliefs can make wages respond quickly to inflationary forces but sluggishly to deflationary ones. I microfound asymmetric household expectations using ambiguity-aversion: households, who do not know the quality of their information, overweight inflationary news since it reduces their purchasing power, and underweight deflationary news since it increases their purchasing power. I embed asymmetric beliefs into a general equilibrium model and show that, in such a model, monetary policy has asymmetric effects on employment, output, and wage inflation in ways consistent with the data. Although wages are downwardly rigid in this environment, monetary policy need not have a bias towards using inflation to grease the wheels of the labor market.

Suggested Citation

  • David Rezza Baqaee, 2015. "Asymmetric Inflation Expectations, Downward Rigidity of Wages and Asymmetric Business Cycles," Discussion Papers 1601, Centre for Macroeconomics (CFM).
    • Handle: RePEc:cfm:wpaper:1601
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    2. Riccardo M Masolo & Francesca Monti, 2021. "Ambiguity, Monetary Policy and Trend Inflation," Journal of the European Economic Association, European Economic Association, vol. 19(2), pages 839-871.
    3. Gorodnichenko, Yuriy & Sergeyev, Dmitriy, 2021. "Zero Lower Bound on Inflation Expectations," IZA Discussion Papers 14853, Institute of Labor Economics (IZA).
    4. Gabriel Chodorow-Reich & Johannes Wieland, 2020. "Secular Labor Reallocation and Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 128(6), pages 2245-2287.
    5. David O. Cushman & Glauco De Vita & Emmanouil Trachanas, 2023. "Is the Fisher effect asymmetric? Cointegration analysis and expectations measurement," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(4), pages 3727-3748, October.
    6. Nagel, Stefan & Yan, Zhen, 2022. "Inflation Hedging on Main Street? Evidence from Retail TIPS Fund Flows," CEPR Discussion Papers 17695, C.E.P.R. Discussion Papers.
    7. khan, sajawal, 2018. "Managing the Expectations and Monetary Policy effectiveness: Role of Inflation Targeting," MPRA Paper 93170, University Library of Munich, Germany, revised 20 Feb 2019.
    8. Dmitri V. Vinogradov & Michael J. Lamla & Yousef Makhlouf, 2024. "Survey-based expectations and uncertainty attitudes," Working Papers 2024_02, Business School - Economics, University of Glasgow.
    9. Donayre, Luiggi, 2022. "On the behavior of Okun's law across business cycles," Economic Modelling, Elsevier, vol. 112(C).
    10. Tura-Gawron, Karolina, 2019. "Consumers’ approach to the credibility of the inflation forecasts published by central banks: A new methodological solution," Journal of Macroeconomics, Elsevier, vol. 62(C).
    11. Cosmin L. Ilut & Martin Schneider, 2022. "Modeling Uncertainty as Ambiguity: a Review," NBER Working Papers 29915, National Bureau of Economic Research, Inc.
    12. Tsai, I-Chun, 2020. "Alternative explanation of the money illusion: The effect of unexpected low inflation," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 110-123.
    13. Metiu, Norbert & Prieto, Esteban, 2023. "The macroeconomic effects of inflation uncertainty," Discussion Papers 32/2023, Deutsche Bundesbank.
    14. Sias, Richard & Starks, Laura T. & Turtle, H.J., 2023. "The negativity bias and perceived return distributions: Evidence from a pandemic," Journal of Financial Economics, Elsevier, vol. 147(3), pages 627-657.
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    16. Karolina Tura-Gawron & Maria Siranova & Karol Fisikowski, 2018. "ARE CONSUMER INFLATION EXPECTATIONS AN INTERNATIONAL PHENOMENON? Results of spatial panel regressions models," GUT FME Working Paper Series A 50, Faculty of Management and Economics, Gdansk University of Technology.

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    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications

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