Inflation expectations, central bank credibility and the global financial crisis

Petra Gerlach-Kristen,Richhild Moessner

doi:10.1007/bf03399402

Petra Gerlach-Kristen, Richhild Moessner

Open Access

https://doi.org/10.1007/bf03399402

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Abstract

Summary Long-run inflation expectations should not respond to economic news if the central bank is seen as credibly committed to stabilising inflation. In this paper we find that since the onset of the global financial crisis, medium and long-term inflation expectations implied by inflation swaps in the euro area, United Kingdom and United States have become less responsive to actual inflation and changes in oil and food prices. This suggests that the credibility of the central banks in these economies remains intact, despite large increases in their balance sheets due to unconventional monetary policy measures and the introduction of explicit forward guidance at the zero lower bound. We also find an increase in autocorrelation of inflation expectations, which suggests that shocks have a longer-lasting impact than before the financial crisis.

Highlights

In late 2008, economic activity in the major advanced economies contracted sharply and actual and expected inflation rates dropped
We find that since the onset of the global financial crisis, inflation expectations in the euro area, United Kingdom and United States three, five and ten years ahead have become less responsive to actual inflation and changes in oil and food prices
This suggests that the credibility of the central banks in these economies remains intact, despite large increases in their balance sheets due to unconventional monetary policy measures and the introduction of explicit forward guidance at the zero lower bound

Summary

Introduction

In late 2008, economic activity in the major advanced economies contracted sharply and actual and expected inflation rates dropped. We find that since the onset of the global financial crisis, inflation expectations in the euro area, United Kingdom and United States three, five and ten years ahead have become less responsive to actual inflation and changes in oil and food prices This suggests that the credibility of the central banks in these economies remains intact, despite large increases in their balance sheets due to unconventional monetary policy measures and the introduction of explicit forward guidance at the zero lower bound. The rise in volatility appears due to the changed autocorrelation and larger shocks Overall, these findings suggest that the credibility of the central banks in the euro area, the United Kingdom and the United States remains intact, especially in the long run.

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SUMMARY