TITLE:
Anchoring Heuristic Messes with Inflation Targeting
AUTHORS:
Evelin Da Silva, Sergio Da Silva
KEYWORDS:
Anchoring Heuristic, Inflation Targeting, Adaptive Learning
JOURNAL NAME:
Open Access Library Journal,
Vol.2 No.4,
April
14,
2015
ABSTRACT:
We evaluate recent inflation-targeting using Brazilian data and also
consider the framework of the macroeconomic model of adaptive learning blended
with a cognitive psychology approach. We suggest that forecasters interpret the
inflation target as an anchor, and adjust to it accordingly. As current
inflation increases above the target level, a central bank loses credibility,
and forecasters start the adjustment from the top because they expect an even
higher future inflation. Then, they move back to the core target within a range
of uncertainty, but the adjustment is likely to end before the core is reached,
as predicted by the psychological theory of anchors. After calibrating the
model, we find an asymptotic equilibrium of a 6.1 percent inflation rate, which
overshoots the announced target inflation core of 4.5 percent. This example
casts doubt on the very justification for inflation targeting, which is
unlikely to succeed when private forecasters rely on anchoring heuristics.