What Do (and Don't) Forecasters Know About U.S. Inflation?

Abstract

This paper contributes to and extends our current understanding of information frictions in expectations. I first propose a new framework for estimating noisy information using individual forecasts. I further extend this framework to incorporate misperceptions on the part of economic agents about the persistence of the underlying process being forecasted. Applying this framework to the U.S. inflation, forecasts of professional forecasters suggest a systematic overestimation on the part of forecasters of the persistence of inflation in addition to the presence of noisy signals. Using a structural model that incorporates both noisy signals and misperceptions of persistence, I quantify the relative importance of each channel in accounting for the expectations formation process of these agents. The results indicate that, even for professional forecasters, there are multiple forces that generate economically significant deviations from full information.