Articles Food Prices, Expectations, and Inflation

This paper explores a hypothesis about the formation of inflation expectations, popular among policy makers, which states that economic agents place a greater weight on the recent behavior offood prices when forming expectations than expenditure shares would indicate. This hypothesis is termed the biased expectations hypothesis (BEH). Using a stochastic fixprice-flexprice model of the U.S. economy, I derive the implications of the BEH for the overall rate of inflation and demonstrate that a bias in the formation of expectations may be Muth-rational. The empirical results suggest that there is no bias in the formation of expectations of any consequence for policy. Key words: anti-inflation policy, food price shocks, rational expectations. The hypothesis that the recent behavior of food prices plays a special role in the forma-tion of consumers ' expectations of inflation appears to be widely held by policy makers and economists in the United States. The 1976 Economic Report of the President, for exam-ple, states this hypothesis clearly: Food prices are the most visible and best publicized of all the components of the CPI. For this reason they may be especially important in determining the wage demands of labor and the inflationary expectations of all consumers (p. 34). This hypothesis, which I call the biased expec-tations hypothesis (BEH), was prevalent at the Cost of Living Council, the government agency responsible for administering wage and price controls in the early seventies, and it appears to have figured prominently in the de-cisions to impose meat price ceilings in March 1973 and agricultural export controls in th