A Panel Smooth Transition Regression Model for the Determinants of Inflation Expectations and Credibility in the ECB and the Recent Financial Crisis

Abstract

This paper studies the determinants of inflation expectations and credibility in the European Central Bank (ECB) during the first decade of European monetary policy. As a measure of credibility we use the gap between the professional economists' inflation forecasts and the ECB's inflation objective. In addition, we investigate whether the main driving factors of inflation expectations and credibility have changed during the recent financial crisis. Within a panel data approach we use Consensus Economics Forecasts in a real-time framework over the period December 2002-May 2010. First, we find that the history of inflation honesty, the forecasts of real GDP growth, M3 growth and the industrial producers' price inflation appear as key determinants of the inflation expectations and the credibility gap in the ECB. Second, within a Panel Smooth Transition Regression (PSTR) modeling we account for a change of regime in the determinants of the inflation forecasts and the credibility in the Central Bank. Finally, we provide new evidence on the impact of the recent non conventional monetary policy operations on the inflation credibility dynamics of the ECB. Using the ratio of Longer-Term Refinancing Operations (LTRO) and the ratio of Securities in the total assets held by the ECB as transition variables, we find that the impact of the key explanatory variables has changed at the onset and at the peak of the financial crisis respectively.