Learning from Inflation Experiences

Abstract

How do individuals form expectations about future inflation? We propose that individuals overweight inflation experienced during their lifetimes. This approach modifies existing adaptive learning models to allow for age-dependent updating of expectations in response to inflation surprises. Young individuals update their expectations more strongly than older individuals since recent experiences account for a greater share of their accumulated lifetime history. We find support for these predictions using 57 years of microdata on inflation expectations from the Reuters/Michigan Survey of Consumers. Differences in experiences strongly predict differences in expectations, including the substantial disagreement between young and old individuals in periods of highly volatile inflation, such as the 1970s. It also explains household borrowing and lending behavior, including the choice of mortgages. JEL Codes: E03, G02, D03, E31, E37, D84, D83, D14.