Heterogeneous Expectations, Learning and European In‡ation Dynamics

Abstract

This paper provides a …rst attempt to investigate how dierent learning rules per- form in explaining survey data on in‡ation expectations of households and professional forecasters in …ve core European economies (France, Germany, Italy, Netherlands and Spain). It is shown that adaptive learning algorithms with constant gain perform well in out-of-sample forecasting and that households in countries with a history of high in‡ation use higher constant gain parameters to predict in‡ation than those in coun- tries with low in‡ation. They are hence able to pick up structural changes faster. Professional forecasters update their information sets more frequently than households. Furthermore, household expectations in the Euro Area have not converged to the in- ‡ation objective of the ECB, which is to keep in‡ation below but close to 2% in the medium term. This contrasts with the …ndings for experts, which seem to be more in- clined to incorporate the implications of monetary union for the convergence in in‡ation rates into their expectations.

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