A Study On Bounded Rationality And Heterogeneity Of Residents’ Inflation Expectations

The managing of inflation expectations has become the core function of every central bank. In order to effectively manage the inflation expectations, studying of properties of the inflation expectations is needed. Many scholars proposed different expectation theories to study the properties of inflation expectation. From the 1970 s, the theory of rational expectations dominated. But since the 1990 s, some studies indicated that expectation was not completely rational, which led to the emerging of bounded rationality expectation theory. There are a lot of theoretical and empirical debates about whether inflation expectation is rational or bounded rational. Meanwhile, some foreign surveys indicate that a significant difference(heterogeneity) of inflation expectations exists among different resident groups. But a systematic study of the reasons behind is missing. On one hand, this article is to find out whether residents’ inflation expectations of China are rational or bounded rational. On the other hand, the article studies the cause of the heterogeneity of residents’ inflation expectations. This can provide significant reference for government’s making of macro regulating policies.In the theoretical analysis, because of the information searching cost, individuals can only approach rational expectation on a limited scale, instead of efficiently using all the effective information to forecast. Thus expectations are bounded rational. Furthermore, under the condition of bounded rational expectation, people of different characteristics will show a significant heterogeneity. The article analyzes the impact of shopping frequency, financial condition, asset allocation, and inflation knowledge on inflation expectations. The result indicates that individuals which shop more frequently, have poorer financial conditions or have less inflation knowledge will form a stronger inflation expectation and individuals with different asset allocations and related experience have different expectations.The main empirical study is divided into two parts(Chapter 4 and 5). Chapter 4 uses the data from urban depositors’ questionnaire of PBC to study the bounded rationality of inflation expectations. The article conducts tests of unbiasedness, effectiveness, the mean of deviation is 0 and there is no autocorrelation, which are three conditions required by rational expectations. The conclusion is that residents can’t use all the effective data, and there is an autocorrelation existing in their cognition bias. Thus, their expectation is bounded rational. Furthermore, it confirms the conclusion with survey data and psychological experiment. Chapter 5 studies the heterogeneity of inflation expectation using survey data. The article studies whether every consumer’s demographics can have a significant effect on inflation expectations, and then conducts multivariate regression. Finally, the article finds out the factors behind consumers’ inflation expectations heterogeneity using factor analysis. Furthermore, this article uses psychological experiment to conduct further test.This article concludes that:(1) residents’ inflation expectation is bounded rational, and they use limited information resource and an autocorrelation exists in their cognitive deviation.(2)There is a significant heterogeneity in consumers’ inflation expectations.(3) Individuals’ inflation expectations are significantly influenced by their shopping frequency, economic conditions, asset allocation experience, and inflation knowledge. The more frequently they shop, the worse their economic condition is, the less inflation knowledge they have, individuals have higher inflation expectations. And asset allocation and experience also influence consumers’ inflation expectations.This article has several innovations.(1)The article discusses the factor behind the heterogeneity, while existing studies only indicate inflation expectations are related to demographics like gender, age, education and income.(2)The article uses methods including survey and psychological experiment. Both results can be validated by each other. Meanwhile, there appears to be some deficiencies as well. Firstly, there is no access to PBC’s survey result, so we use the data from a project of National Natural Science Foundation. Secondly, during the psychological experiment, we only investigated the influence of gender and price frequency on inflation expectations, instead of a better scheme to study the influence of economic conditions and inflation knowledge on inflation expectations.