Events at CERGE-EI

Prof. Davide Debortoli

Universitat Pompeu Fabra, Spain

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Meeting number: 2740 810 3375
Meeting password: 483276

Authors: Davide Debortoli, Luigi Iovino, Nicola Pavoni and Donghai Zhang

Abstract: This paper develops a macroeconomic framework with limited-awareness (LA), where agents are not fully aware of the structural sources of economic fluctuations. We demonstrate that LA induces systematic mis-perceptions of the relationships among macroeconomic variables, such as a bias in the perceived inflation–unemployment trade-off. Using individual expectations data from the Survey of Professional forecasters, we document empirically the presence of such a bias, and that forecasters perceive a substantially flatter Phillips curve than in the data. We then introduce LA into a stylized New Keynesian model featuring LA, in which agents fail to fully recognize the occurrence of some supply-side disturbances and partially conflate them with demand shocks. Within this framework, demand shocks generate higher output volatility, whereas inflation volatility is attenuated relative to the benchmark of rational expectations. Our findings call into question the desirability of inflation targeting in environments where agents do not possess full awareness of the structural sources of macroeconomic fluctuations.