Comments on “How do firms form their expectations Comments on “How do firms form their expectations? New survey evidence” by Coibion, Gorodnichenko, and Kumar Inflation, Monetary Policy, and the Public. Federal Reserve Bank of Cleveland, May 29, 2014, Jamie McAndrews* *The views expressed are my own and do not necessarily represent the views of the FRBNY or the Federal Reserve System.

Summary • Paper conducts survey of ~3,100 small and medium-sized businesses in New Zealand (between September 2013 and January 2014) with one follow-up survey (~700 firms, between February and April 2014) • Main findings: survey responses of business managers much more similar to those of consumers than those of professional forecasters: upward bias in inflation perceptions and expectations, and large dispersion/disagreement in beliefs across respondents. • Conclusion: Strong evidence of informational frictions, consistent with rational inattention motives.

Why is this important? Previous research on disaggregated prices (Boivin, Giannoni, Mihov AER 2009; Mackowiak, Moench, Wiederholt JME 2009) has documented slow, persistent response of sectoral prices to aggregate (e.g. monetary) shocks and fast, non-persistent response to sector-specific shocks Implies slow transmission of monetary policy shocks to aggregate price level MMW: This can be explained with rational inattention models, difficult to explain with other models of price setting (e.g. Calvo)

Is it really inattention? Unclear why inattention should imply high, extreme answers to survey questions. Maybe it reflects numeracy/financial literacy skills.   Maybe respondents use a different measure for overall inflation. Are results driven by outliers due to measurement or reporting errors? Point forecasts may not equal expected values.

Any other evidence of learning or updating? Armantier et al (2014) shows individuals update after receiving new information Evidence from SCE that asking about inflation and other concepts leads to some learning, with extreme responses occurring less frequently and people indicating more familiarity with inflation as they participate in additional waves of the survey.

Outliers decline with Tenure: Tenure vs. Outliers (Average %) (Topa and Bleemer) One Year Inflation Point Predictions Three Year Inflation Point Predictions T-test of equality, tenures 1 vs. 2: p=0.0003 T-test of equality, tenures 3 vs. 4: p=0.0293 T-test of equality, tenures 4 vs. 5: p=0.1378 T-test of equality, tenures 1 vs. 2: p=0.0470 T-test of equality, tenures 3 vs. 4: p=0.3923 T-test of equality, tenures 4 vs. 5: p=0.3162

Forecast uncertainty declines with Tenure: Tenure vs. Forecast Uncertainty (Topa and Bleemer) One Year Inflation Three Year Inflation T-test of equality, tenures 1 vs. 2: p=0.0002 T-test of equality, tenures 4 vs. 5: p=0.2654 T-test of equality, tenures 5 vs. 6: p=0.1937 T-test of equality, tenures 1 vs. 2: p=0.0000 T-test of equality, tenures 4 vs. 5: p=0.0816 T-test of equality, tenures 5 vs. 6: p=0.2326

Implications for Macro modeling In previous work, Coibion & Gorodnichenko (2011,2012) have documented that survey responses from households and professional forecasters are consistent with imperfect (noisy/sticky) information models; Andrade, Crump , Eusepi, Moench (2014) show complementary results. This paper: firms disagree much more about aggregate conditions than professional forecasters or even households. Does this imply levels of information imperfection that would generate implausibly large aggregate persistence in general equilibrium? More precisely, can one calibrate rational inattention models of Mackowiak&Wiederholt (2009, 2012) to your survey data and see what this would imply about inflation persistence?

Other implications Whether firms’ inflation expectations are well anchored is relevant only if firms act on their reported beliefs.  Note the low rate of inflation in NZ for a long time. In terms of unanchoring of expectations, finding high expectations for some respondents may not be of great concern. Assuming that the proportion of respondents providing extreme responses is relatively stable over time, to identify evidence of possible unanchoring, the focus should be more focused on changes in expectations over time. If the inflation rate is low, fewer price changes will be made by firms, so they could become inattentive to inflation, unanchoring expectations. For example, if inflation were higher it would be more salient to people and firms, and agents would pay more attention, increasing the precision of their forecasts.