Global inflation dynamics and inflation expectations

Abstract

In this paper we investigate dynamics of inflation and short-run inflation expectations. We estimate a global vector autoregressive (GVAR) model using Bayesian techniques. We then explore the effects of three source of inflationary pressure that could drive up inflation expectations: domestic aggregate demand and supply shocks as well as a global increase in oil price inflation. Our results indicate that inflation expectations tend to increase as inflation accelerates. However, the effects of the demand and supply shocks are short-lived for most countries. When global oil price inflation accelerates, however, effects on inflation and expectations are often more pronounced and long-lasting. Hence, an assessment of the link between observed inflation and inflation expectations requires disentangling the underlying sources of inflationary pressure. We also examine whether the relationship between actual inflation and inflation expectations changed following the global financial crisis. The transmission between inflation and inflation expectations is found to be largely unaffected in response to domestic demand and supply shocks, while effects of an oil price shock on inflation expectations are smaller post-crisis.