Beliefs That Move the Economy: Shocks to Firms’ and Households’ Inflation Expectations

Abstract

This paper examines shocks to inflation expectations and argues that distinguishing between households’ and firms’ expectations is crucial for understanding their macroeconomic role. First, using an analytical example, I demonstrate that shocks to firms’ expectations are stagflationary, whereas shocks to households’ expectations are expansionary. Second, household expectations are found to be more exposed to expectation shocks than those of firms. Third, shocks to firms' inflation expectations are a key driver of output, inflation, and real wages, while shocks to households' expectations contribute primarily to wage dynamics. These results imply that monetary policy should place greater weight on firms’ expectations than on those of households.