ABSTRACT
Whether it provides a prescription for an optimal inflation rate or not, the ADP model gives a rationale for why a central bank might target inflation at a moderately positive level, which, in practice, virtually every central bank with an inflation target has chosen to do.6 The existence of nearly-rational agents as described in ADP implies that a central bank must produce a modest inflation if the minimization of unemployment is among its long-run objectives.7 This chapter tests whether the assumption of near-rationality conforms to households’ inflation expectations as measured by survey data. Section 2 argues that the evidence provided in ADP is consistent with any set of expectations that are less-than-fully rational. To test their particular form of expectations formation – near-rationality – one needs to bring the theory to actual data on agents’ expectations. We do this in Section 3, which considers the case of near-rational-
ity using survey data for households, first in the aggregate data, and then in micro-survey data. We find that these survey data fail to reveal the correspondence between nearly-rational agents and inflation that ADP suggest. Section 4 concludes.
