Economic Literacy and Inflation Expectations: Evidence from a Laboratory Experiment

We present new experimental evidence on heterogeneity in the formation of inflation expectations and relate the variation to economic literacy and demographics. The experimental design allows us to investigate two channels through which expectations-formation may vary across individuals: (1) the choice of information and (2) the use of given information. Subjects who are more economically literate perform better along both dimensions—they choose morerelevant information and make better use of given information. Compared with survey data on inflation expectations, fewer demographic factors are associated with variation in inflation expectations, and economic literacy in most cases accounts for demographic variation in expectations. JEL Classifications: E31, E37, E52 Mary A. Burke is a Senior Economist at the Federal Reserve Bank of Boston. Her email address is [email protected]. Michael Manz is Head of the Section for International Finance and Financial Stability of the Swiss State Secretariat for International Finance. His email address is [email protected] . This paper, which may be revised, is available on the web site of the Federal Reserve Bank of Boston at: http://www.bostonfed.org/economic/ppdp/index.htm This paper presents preliminary analysis and results intended to stimulate discussion and critical comment. The views expressed herein are those of the authors and do not indicate concurrence by other members of the research staff or principals of the Federal Reserve Bank of Boston, the Board of Governors, or the Federal Reserve System. In addition, the views expressed in this paper do not necessarily reflect those of the Swiss State Secretariat for International Finance. We would like to acknowledge Carl Nadler and Kevin Todd for extensive research assistance. For helpful comments and other important contributions, we thank Jeff Fuhrer, Geoff Tootell, Giovanni Olivei, Bob Triest, Anat Bracha, Julian Jamison, Michelle Barnes, Fabià Gumbau-Brisa, Jane Little, Stephan Meier, Tanya Rosenblat, Lena Drager, Steffan Ball, and seminar and conference participants at the Boston Fed, New York Fed, Brandeis University, and St. Louis Fed. We also wish to thank Mark Edington and the staff at the Harvard Decision Sciences Lab, staff and students at Roxbury Community College for participating in test experiments, and Deborah Bloomberg at the Boston Fed for facilitating our pre-tests. This version: November 2011 Research Center for Behavioral Economics