Disagreement and Biases in Inflation Expectations


  • We are grateful to two anonymous referees as well as the editor, Pok-sang Lam, for many valuable comments. We have also benefited from discussions with seminar participants at Banco de México, UCSD, LAMES 2007, and the 2006 Meetings of the Society of Computational Economics. Gabriel López-Moctezuma provided excellent research assistance. Allan Timmermann acknowledges support from CREATES funded by the Danish National Research Foundation. The opinions in this paper are those of the authors and do not necessarily reflect the point of view of Banco de México.


Disagreement in inflation expectations observed from survey data varies systematically over time in a way that reflects the level and variance of current inflation. This paper offers a simple explanation for these facts based on asymmetries in the forecasters' costs of over- and underpredicting inflation. Our model implies (i) biased forecasts, (ii) positive serial correlation in forecast errors, (iii) a cross-sectional dispersion that rises with the level and the variance of the inflation rate, and (iv) predictability of forecast errors at different horizons by means of the spread between the short- and long-term variance of inflation. We find empirically that these patterns are present in inflation forecasts from the Survey of Professional Forecasters. A constant bias component, not explained by asymmetric loss and rational expectations, is required to explain the shift in the sign of the bias observed for a substantial portion of forecasters around 1982.