Are Inflation Expectations Rational in New Zealand?

Abstract

This paper examines the rationality of inflation expectations in New Zealand. A number of econometric tests show that the main New Zealand expectational-inflation series tend to be non-stationary. Any further test for rational inflation expectations amounts to some test for the case where the actual and expectational inflation series cointegrate in an error-correction model. Put differently, there should be no long-run difference between these two series, and innovations in one of these series should match innovations in the other. The evidence in support of a long-run relationship between actual and expectational inflation series calls for the implementation of the unbiasedness test proposed by Kremers, Ericcson, and Dolado (1992). These tests suggest that both New Zealand actual and expectational inflation series appear to be non-stationary. In particular, these series appear to be integrated of order 1 or I(1). Thus the levels of these series appear to be non-stationary while the first differences of these series are stationary. The subsequent tests focus on the presence or absence of a cointegrating link between actual and expectational inflation. A number of cointegration tests show that most New Zealand inflation expectations cointegrate with actual inflation. Furthermore, inflation expectations appear to Granger-cause actual inflation. But actual inflation does not seem to have a feedback effect on inflation expectations. Lastly, the RBNZ's 1-year ahead inflation forecasts serve as the only unbiased predictor of actual inflation. All the other expectational inflation series fail the test for unbiasedness. This finding suggests that the RBNZ may have access to better information about the future course of actual inflation.