| Abstract: |
We use panel data on expected and realized changes in household finances to
study the process of expectation formation. Households extrapolate from
improvements in financial situation, but deteriorations are associated with an
increased dispersion of forecasts, and higher probabilities of both negative
and positive forecast errors. Individuals who expect earnings declines to
revert too quickly save less and are more likely to be financially worse off
again in the future. Learning from past errors reduces the likelihood that
individuals are optimistic following a deterioration in their finances. The
evidence shows how experiences, learning, and life events matter for
expectation formation. |