Expectations Formation and Inflation Persistence

This paper studies the dynamics of inflation if monetary policy is transparent only to part of the population. We find that average long-run inflation decreases in the proportion of agents with naive expectations and, because of tradeoffs between speed of adjustment and long-run inflation, central banks prefer a higher proportion of agents who form informed expectations in high inflation periods but not so in lower inflation periods. We use survey data on expectations of inflation from Bulgaria collected at the time a currency board was introduced in that country to test for influences on the heterogeneity of expectations across agents