Deviating from full rationality but not from theoretical consistency: The behavior of inflation expectations in Brazil

• Published in: The Quarterly review of economics and finance Vol. 84; pp. 492 - 501
• Main Authors: Cambara, Leilane de Freitas Rocha, Meurer, Roberto, Lima, Gilberto Tadeu
• Format: Journal Article
• Language: English
• Published: Elsevier Inc 01-05-2022
• Subjects: deviations from full rationality; forecast errors in surveys; Inflation expectations in Brazil; D84; forecast errors in surveys; E31; deviations from full rationality; E10; Inflation expectations in Brazil
• ISSN: 1062-9769; 1878-4259
• DOI: 10.1016/j.qref.2020.10.002

•We reject the hypothesis of full rationality of inflation expectations in Brazil.•Inflation forecast errors of survey respondents are biased and can be predicted.•Deviations from full rationality cannot be explained by information rigidity.•Expectations about related variables respond to each other as predicted by theory.
The aim of this paper is to investigate whether inflation expectations in Brazil have characteristics and statistical properties that can be correlated (possibly in a causal way) with observed variables of interest and expectations about them. Our analysis covers the period from December 2001 to August 2018. We test the hypothesis of rational expectations in the formation of inflation expectations by the respondents of the official survey conducted by the Central Bank of Brazil, examining the behavior of their forecast errors. As these errors are biased and can be predicted, we reject the hypothesis of full rationality. We also test models of noisy and sticky information, and we cannot conclude that the deviations from full rationality can be explained by information rigidity. Additionally, with a vector error correction model, we find evidence that the expectations about the related macroeconomic variables respond to each other as predicted by a theoretically-grounded macroeconomic model. Therefore, inflation expectations in Brazil are to an important extent consistent with more general expectations about the future performance of the economy.