Evidence on Expectations of Household Finances

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.

This paper was accepted by Camelia Kuhnen, finance.

Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.03257.