Expectations is an important channel in the transmission mechanism of monetary policy. Well-anchored inflation expectations allow central banks to achieve price stability and lessen the volatilities and gyrations in the economy. Thus, understanding how expectations are formed by economic agents such as households is important for monetary policy decisions and actions. The study uses the results of the Consumer Expectation Survey (CES), a quarterly survey of households conducted by the BSP, to evaluate whether survey-based subjective expectations in the Philippines deviate from rational expectations and to determine the factors that drive household expectations in the country. Moreover, it examines the behavior of household expectations over time and how these relate to changes in the country’s inflation dynamics.
The study finds little evidence that expectations from the CES are characterized by rationality (i.e., unbiased and efficient). This implies that Filipino households do not utilize all available information and they rely more on information about past inflation to form expectations of future inflation. However, in recent years, Filipino households are observed to have started incorporating more information about future outcomes in their expectation formation process. The study’s empirical results show the significant effect of income conditions, perceptions on economic and financial conditions, the inflation target, demographic factors (e.g., educational attainment, marital status, gender) and uncertainty (as proxied by a news-based measure) on the formation of household expectations in the Philippines.
Moreover, the observations from the study provide some insights for central bank communication strategy, particularly in influencing household expectations. First, households are different from professional forecasters and financial market participants when forming their expectations. Second, households have become more forward-looking in their assessment of current inflation and therefore they adjust their expectations more to new information. Third, less uncertainty about future economic outcomes leads to lower expected inflation. Fourth, economic and learning programs could contribute to lower household inflation expectations.