Essays on Inflation Expectations, Monetary Policy and Tax Reform

Abstract: This thesis consists of three self-contained essays.Essay I: Why do consumers’ expenditure patterns matter for their inflation expectations? I propose a model of rational inattention where a consumer trades off paying attention between goods bought more or less frequently. For each good purchased, the consumer observes the rate of price change with an error that depends on the frequency at which the good is purchased. Goods bought less frequently are observed with a greater level of error. I apply a simple version of the model where the inflation index is decomposed into two sub-index components; one sub-index contains goods bought often, and the other contains goods that are not bought often. My results show that the consumer pays more attention to goods bought often. The model is able to match about 60% of the variation in the inflation expectations of the average Swedish household over the time period 2002-2017. A decomposition of the model shows that the consumer’s attention allocation trade-off between these two sub-index components is an important factor in the model’s ability to explain the variation in inflation expectations expressed by Swedish households.Essay II: What is the effect of monetary policy announcements on inflation expectations? Using survey data of Swedish households’ inflation expectations over the time period 2003-2015, I examine this question using a two-stage least squares regression model. The announced changes are instrumented by a monetary policy surprise variable, obtained from high-frequency swap trade data. I find that the immediate effect of an announced increase in the policy rate on inflation expectations is significant and positive. This result may be interpreted as the policy announcement signaling the central bank’s private information on the direction of future inflation. Specifically, a division of the monetary policy surprise associated with each announcement as either a pure monetary policy surprise or an information surprise shows that the effect of an announced increase in the policy rate on inflation expectations is significant and positive only for the latter type of surprise.Essay III (with Charlotte Paulie and Markus Ridder): For the past several decades, wealth inequality has increased in many countries. Do changes in the tax system contribute to these trends? Using a quantitative model, we examine the effect on wealth inequality of changing from a comprehensive to a dual tax system. We start with a standard open-economy incomplete-markets model, to which we add an entrepreneurial sector. The entrepreneurs in the model exploit the duality of the tax system after the reform by declaring income as capital (taxed at a flat rate) rather than labor income (taxed progressively). The model is parameterized to match the characteristics of the Swedish economy under dual taxation. In contrast to previous studies, we estimate the parameters of the stochastic process for entrepreneurial income using micro-data observations. We find that the introduction of a dual tax system increases wealth inequality and that the possibility of the entrepreneurs to declare income as capital plays an important role for this result. We also find that the level of aggregate capital and the share of entrepreneurs is higher in an economy with a dual tax system.