Experimental Evidence on Inflation Expectation Formation (Replaced by CentER DP 2011-091)

Using laboratory experiments, we establish a number of stylized facts about the process of inflation expectation formation. Within a New Keynesian sticky price framework, we ask subjects to provide forecasts of inflation and their corresponding confidence bounds. We study individual responses and properties of the aggregate empirical distribution. Many subjects do not rely on a single model of expectation formation, but are rather switching between di¤erent models. About 40% of the subjects predominately use a rational rule when forecasting inflation and about 35% of agents simply extrapolate trend. Around 5% of subjects behave in an adaptive manner, while the remaining 20% behaves in accordance to adaptive learning and sticky information models. Furthermore, we find that subjects in only 60% of cases correctly perceive the underlying uncertainty in the economy when reporting confidence intervals. However, empirical analysis does not support a significant countercyclical behavior of individuals' confidence intervals.