Anchoring Heuristic Messes with Inflation Targeting

Evelin Da Silva¹, Sergio Da Silva^2*

¹Department of Economics and International Relations, Federal University of Santa Catarina, Florianopolis, Brazil.
²Graduate Program in Economics, Federal University of Santa Catarina, Florianopolis, Brazil.

DOI: 10.4236/oalib.1101450                

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.

Keywords

Anchoring Heuristic, Inflation Targeting, Adaptive Learning

Conflicts of Interest

The authors declare no conflicts of interest.

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