Title: Contextual Expectations: A Novel Framework for Modeling Inflation Dynamics

Author: 
Ceyhun Elgin - Bogazici University

Abstract:

This paper introduces the Contextual Expectations (CE) framework, a novel approach to modeling inflation expectations that incorporates multiple dimensions of information and individual context. I develop a comprehensive mathematical formulation of the CE model, including a contextual relevance function that determines the weights assigned to different information sources. Theoretical analysis demonstrates that the CE model has significant implications for inflation dynamics, monetary policy effectiveness, and macroeconomic stability, encompassing Rational Expectations and Adaptive Expectations as special cases while allowing for more complex dynamics. I calibrate the model using Turkish economic data and conduct simulation exercises to illustrate its properties. To provide direct empirical grounding, I also present evidence from a randomized information–update experiment that causally identifies how central bank communication, recent inflation data, and salient news affect individual expectation formation. The results show that central bank guidance reduces expected inflation when credibility and trust are high, while backward-looking signals exert stronger influence among households with higher similarity to CPI baskets. Mapping these micro estimates into the CE framework yields empirical weights that align with the model’s predictions and discipline its calibration. Together, the theoretical, simulation, and experimental results suggest that the CE framework offers valuable insights for monetary policy design and implementation, particularly regarding the credibility and communication strategies of central banks in shaping expectations.

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