Overreaction in Macroeconomic Expectations

Speaker: Pedro Bordalo, with Nicola Gennaioli, Yueran Ma and Andrei Shleifer

This event is part of our CESS Seminar Series

Abstract: We examine the rationality of individual and consensus professional forecasts of macroeconomic and financial variables using the methodology of Coibion and Gorodnichenko (2015), which focuses on the predictability of forecast errors from earlier forecast revisions.  We document two principal findings: at the individual level, forecasters typically over-react to information, while consensus forecasts exhibit under-reaction.  To reconcile these findings, we combine the diagnostic expectations model of belief formation from Bordalo, Gennaioli, and Shleifer (2018) with Woodford’s (2003) noisy information model of belief aggregation.  The model accounts for the findings, but also yields a number of new implications related to the forward looking nature of diagnostic expectations, which we also test and confirm.  Finally, we compare our model to mechanical extrapolation, rational inattention, and natural expectations