How Do Consumers Adapt to a New Environment in their Economic Forecasting? Evidence from the German Reunification

Households' ability to form accurate macroeconomic expectations has major implications for the effectiveness of fiscal and monetary policy. However, forecasting macroeconomic variables is a complex task. Based on evidence from the German Reunification, the authors examine how consumers adapt to a new environment in their macroeconomic forecasting. They document that even decades after the reunification East Germans expect higher inflation and make larger forecast errors than West Germans. Their findings suggest that large changes in the economic environment can permanently impede people's ability to form accurate macroeconomic expectations.