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Inflation expectations in the euro area: are consumers rational?

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Abstract

In this paper, we propose a quantitative measure for inflation expectations based on consumer survey data. Thereafter, we proceed to testing the rationality assumption. This issue is of noteworthy interest in its own as it is commonly assumed in the theoretical modelling literature that the rational expectations hypothesis holds. This analysis is conducted for the euro area as a whole, as well as for several member countries, using a sample covering the last two decades. Moreover, we also assess if the conclusions hold when one focuses on the post-euro introduction period.

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Notes

  1. As stressed by Mestre (2007), the “don’t know” answer is not very informative. Thus, the proportion of respondents that fall in this category are reallocated proportionally to the other response categories (see, for instance, Forsells and Kenny 2002).

  2. Nevertheless, the overall results are qualitatively similar when the observed inflation rate is used as a proxy for the perceived inflation rate.

  3. The other member countries of the euro area as of 1999, namely Finland, Austria and Luxembourg, are not included because the corresponding series for these countries are only available for a shorter time span.

  4. For the euro area, the sample starts in January 1992. For Spain and Portugal, it starts in June 1987. For the remaining countries, the sample starts in January 1986.

  5. In particular, for the euro area, the data refers to HICP, while for individual countries we consider CPI, because a longer time span is available. Nevertheless, if one considers HICP instead of CPI for the common sample period, the results remain virtually unchanged.

  6. The results do not change qualitatively if, instead of the Johansen cointegration test, we consider the single equation test of Engle–Granger. We also computed the cointegrating vector recursively to assess the stability of the relationship and we do not find evidence of parameter instability.

  7. Even though the observed and expected inflation seem to have different means, since the hypothesis of β = 1 is, in general, not rejected, the forecast errors series turn out to be stationary, as confirmed by the ADF test.

  8. As for lags up to 12 months, the existence of autocorrelation can be related with overlapping forecast errors (see, for example, Forsells and Kenny 2002).

  9. Furthermore, these results hold both in the full and post-euro introduction samples.

  10. The number of series considered differs slightly across countries and is, on average, around 50 series. A detailed list of the series is available from the authors upon request.

  11. One should also mention that, concerning both weak- and strong-efficiency, no evidence of a break in the parameter estimates was found at the time of the introduction of the euro.

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Authors and Affiliations

  1. Banco de Portugal, Lisbon, Portugal

    Francisco Dias, Cláudia Duarte & António Rua

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  1. Francisco Dias
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  2. Cláudia Duarte
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  3. António Rua
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Correspondence to António Rua.

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We would like to thank an anonymous referee for helpful comments on the paper.

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Dias, F., Duarte, C. & Rua, A. Inflation expectations in the euro area: are consumers rational?. Rev World Econ 146, 591–607 (2010). https://doi.org/10.1007/s10290-010-0058-6

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