Borradores de Economía - Inflation Expectations: Rationality, Disagreement and the Role of the Loss Function in Colombia

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Rincón-Torres, Andrey Duván
Salas-Ávila, Andrés Felipe
Julio-Román, Juan Manuel

The series Borradores de Economía (Working Papers on Economics) contributes to the dissemination and promotion of the work by researchers from the institution. On multiple occasions, these works have been the result of collaborative work with individuals from other national or international institutions. This series is indexed at Research Papers in Economics (RePEc). The opinions contained in this document are the sole responsibility of the author and do not commit Banco de la República or its Board of Directors.

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We study the behaviour of three quantitative sample surveys and a non sample inflation expectation report for Colombia. We found that expectations in Colombia; (i) are not strongly, i.e. a la Muth, rational because they show cross-section disagreement, (ii) expectations, however, show some features of weak rationality, (iii) expectations disagreement is time varying and relate to inflation, inflation changes and the output gap, thus suggesting a staggered information flow to agents, (iv) the forecast error loss function employed by agents is not symmetric and increasingly penalizes higher expectations than finally observed inflation as the horizon grows, and (v) this fact also explains the stylised fact that observed expectation share with theoretical rational expectations that expectations look like lagged versions of inflation that dampen with the horizon. The latest finding also arises from a very general econometric set up we develop in this paper. These results imply that the effect of weakening the rational expectations assumption in Colombian monetary policy models should be assessed, especially when compared to sticky information and heterogeneous agents choosing non Mean Square forecast Error losses.