Anchor Inflation Expectations Research Articles

Deconstructing credibility: The breaking of monetary policy rules in Brazil

Can political interference deconstruct credibility that was hardly-earned through successful stabilization policy? We analyze the recent switch in the conduct of monetary policy by the Central Bank of Brazil (BCB). Brazil is the largest Emerging Market Economy to formally target inflation, having adopted the Inflation Targeting (IT) regime in 1999. In the early years of IT, the BCB engaged in constructing credibility with price setting agents and succeeded to anchor inflation expectations to its target even under adverse conditions such as exchange rate crises. We argue that this effort to maintain IT rules-based policy ended in 2011, as a new country president and BCB board came to power. We then discuss the consequences of this credibility loss. Our main results can be summarized as follows: (i) we provide strong empirical evidence of the BCB’s shift toward looser, discretionary policy after 2011; (ii) preliminary evidence suggests that this shift has affected agents’ inflation expectations generating social and economic costs.

Central bank policy after the crisis: Example of Serbia

The aim of this paper is to provide a detailed analysis of how the monetary policy of the National Bank of Serbia has been conducted, actively changed and adjusted in the post-crisis period, particularly in the circumstances of increased volatilities in international financial and commodity markets, and also to what extent we have been successful in achieving the legislative mandates - price and financial stability. Particular assessment was made as to whether the instruments that the National Bank of Serbia has used after the global economic crisis, especially after 2012, were appropriate in succesful achieving of those objectives, taking into account current and expected market developments. Achieving and preserving price and financial stability, though facing headwinds from the international environment, undoubtedly confirm that the current framework of monetary and macroprudential policy of the National Bank of Serbia was properly applied and that it delivered desired results. Through all key channels of transmission - the decline in interest rates on new and existing loans, increased availiability of loans and accelerated credit activity, provided relative stability of the exchange rate and well anchored inflation expectations - monetary policy contributed to more favorable business and investment conditions, household consumption and saving, and therefore to sustainable economic growth.

Fiscal Foundations of Inflation: Imperfect Knowledge

This paper proposes a theory of the fiscal foundations of inflation based on imperfect knowledge and learning. Because imperfect knowledge breaks Ricardian equivalence the scale and composition of the public debt matter for inflation. High moderate-duration debt generates wealth effects on consumption demand that impairs the intertemporal substitution channel of monetary policy: aggressive monetary policy is required to anchor inflation expectations. Counterfactual experiments, in an estimated medium-scale DSGE model, reveal the US economy would have been substantially more volatile over the Great Inflation and Great Moderation periods, had average debt been consistent with levels currently observed in Italy or Japan.

Trust in the Central Bank and Inflation Expectations

Using micro data from the 2015 Dutch CentERpanel, we examine whether trust in the European Central Bank (ECB) influences individuals’ expectations and uncertainty about future inflation, and also whether it anchors inflation expectations. We find that higher trust in the ECB lowers inflation expectations on average, and significantly reduces uncertainty about future inflation. Moreover, results from quantile regressions suggest that trusting the ECB increases (lowers) inflation expectations when the latter are below (above) the ECB’s inflation target. These findings hold after controlling for people’s knowledge about the objectives of the ECB. In addition, higher trust in the ECB raises expectations about GDP growth. The findings suggest that a central bank can influence the economy through people’s expectations, even in times when conventional monetary policy tools likely have weak effects.

When does the cost channel pose a challenge to inflation targeting central banks?

In a sticky-price model where firms finance their production inputs, there is both a lower and an upper bound on the central bank's inflation response necessary to rule out the possibility of self-fulfilling inflation expectations. This paper shows that real wage rigidities decrease this upper bound, but coefficients in the range of those on the Taylor rule place the economy well within the determinacy region. However, when there is time-variation in the share of firms who finance their inputs (i.e. Markov-switching) then inflation targeting interest rate rules frequently result in indeterminacy, even if the central bank also targets output. Adding a nominal growth target to the policy rule can often alleviate this indeterminacy and therefore anchor inflation expectations.

Do Inflation Expectations Matter for Inflation Forecastability: Evidence from Pakistan

We empirically investigate if the incorporation of inflation expectations helps improve the forecasting performance of a suite of univariate inflation models. Since inflation forecasts are instrumental to the conduct of an effective monetary policy, any possible improvement in the inflation forecastability may tend to enhance the effectiveness of monetary policy—by providing forward guidance both to the monetary authority and the market to effectively anchor inflation expectations. Our results are robust across specifications of our baseline models, sample sizes and forecast horizons. The introduction of inflation expectations, whether contemporaneously or with a 6-months lead improves the predictive ability—both in-sample and out-of-sample for 6 and 12-month horizons. Deterioration however is observed for a 3- month horizon, which point towards the weak representation of the expectations data for a 3- month horizon. JEL Classification: E31, E37 Keywords: Inflation-expectations, Forecast-performance, Pakistan.

Fed Speak on Main Street: Central Bank Communication and Household Expectations

The Federal Reserve emphasizes communication as a tool of monetary policy. Most research focuses on communication with financial markets, rather than with households. Although the Federal Reserve attempts to use its communication strategy to anchor inflation expectations, consumers' expectations are more weakly-anchored than professional forecasters'. Barely half of consumers expect long-run inflation to be near the 2% target. I analyze a range of survey and media data to show that this reflects a combination of low informedness and low credibility. The Fed has not fully adapted to the demands of a media environment characterized by intense competition for audience attention.

Trust in the Central Bank and Inflation Expectations

Using micro data from the 2015 Dutch CentERpanel, we examine whether trust in the European Central Bank (ECB) influences individuals' expectations and uncertainty about future inflation, and whether it anchors inflation expectations. We find that higher trust in the ECB lowers inflation expectations on average and significantly reduces uncertainty about future inflation. Moreover, results from quantile regressions suggest that trusting the ECB increases (lowers) inflation expectations when the latter are below (above) the ECB's inflation target. These findings hold after controlling for people's knowledge about the objectives of the ECB.

Food Inflation in Sub-Saharan Africa: Causes and Policy Implications

This paper analyzes food inflation trends in Sub-Saharan Africa (SSA) from 2000 to 2016 using two novel datasets of disaggregated CPI baskets. Average food inflation is higher, more volatile, and similarly persistent as non-food non-fuel (NF/NF) inflation, especially in low-income countries (LICs) in SSA. We find evidence that food inflation became less persistent from 2009 onwards, related to recent improvements in monetary policy frameworks. We also find that high food prices are driven mainly by non-tradable food in SSA and there is incomplete pass-through from world food and fuel prices and exchange rates to domestic food prices. Taken together, these finding suggest that central banks in low-income countries with high and persistent food inflation should continue to pay attention to headline inflation to anchor inflation expectations. Other policy levers include reducing tariffs and improving storage and transport infrastructure to reduce food pressures.

Food Inflation in Sub-Saharan Africa: Causes and Policy Implications

This paper analyzes food inflation trends in Sub-Saharan Africa (SSA) from 2000 to 2016 using two novel datasets of disaggregated CPI baskets. Average food inflation is higher, more volatile, and similarly persistent as non-food non-fuel (NF/NF) inflation, especially in low-income countries (LICs) in SSA. We find evidence that food inflation became less persistent from 2009 onwards, related to recent improvements in monetary policy frameworks. We also find that high food prices are driven mainly by non-tradable food in SSA and there is incomplete pass-through from world food and fuel prices and exchange rates to domestic food prices. Taken together, these finding suggest that central banks in low-income countries with high and persistent food inflation should continue to pay attention to headline inflation to anchor inflation expectations. Other policy levers include reducing tariffs and improving storage and transport infrastructure to reduce food pressures.

Incorporating anchored inflation expectations in the Phillips curve and in the derivation of OECD measures of the unemployment gap

Inflation has become much less sensitive to movements in unemployment in recent decades. A common explanation for this change is that inflation expectations have become better anchored as a consequence of credible inflation targeting by central banks. In order to evaluate this hypothesis, the paper compares two competing empirical specifications across all OECD economies, where competing specifications correspond to the and specification for deriving measures of the unemployment gap which underlie the OECD Economic Outlook projections. The former OECD specification can be characterised as a traditional Phillips curve, where current inflation is partly explained by an autoregressive distributed lag process of past inflation representing both inertia and inflation expectations formed on the basis of recent inflation outcomes. Conversely, the new approach adjusts this specification to incorporate the notion that inflation expectations are anchored around the central bank’s inflation objective. The main finding of the paper is that the latter approach systematically out-performs the former for an overwhelming majority of OECD countries over a recent sample period. Relative to the backward-looking specification, the anchored expectations approach also tends to imply larger unemployment gaps for those countries for which actual unemployment has increased the most. Moreover, the anchored expectations Phillips curve reduces real-time revisions to the unemployment gap, although these still remain uncomfortably large, in the case of countries where there have been large changes in unemployment. JEL classification: C22, E24, E31, J64 Keywords: Anchored expectations, Phillips curve, equilibrium unemployment, real-time revisions

Gulf Cooperation Council (GCC)—Energy Price Reforms in the GCC—What Can Be Learned From International Experiences?

Energy prices in the GCC countries are low by international standards. These low prices have co-existed with rapid economic development in the region over the past 50 years, but the costs of this policy have also risen in terms of very high energy usage per capita. Providing energy at low prices has also effectively absorbed resources that could otherwise have been invested in human and physical capital or saved for future generations. The implicit cost of low energy prices in the GCC, in terms of foregone revenue, is estimated to be around 5 percent of GDP (about 8 percent of non-oil GDP) this year. GCC countries have been embarking on energy price reform in recent years. The recent decision of the UAE to remove fuel subsidies is an important initiative. Nevertheless, energy prices are generally still below international levels and differ substantially across the GCC countries. In most countries, further steps are needed to raise energy prices to reduce the growth in energy consumption and to support the fiscal adjustment that is necessary in the current lower oil price environment. Evidence in this paper suggests the inflationary impact of higher energy prices in the GCC is likely to be small, and while there may be some adverse effect on growth in the near-term, over the longer-term the growth benefits should be positive. Given the low weight of energy products in the CPI, first round effects of higher energy prices should be limited, while well anchored inflation expectations should help prevent second-round effects. On growth, a gradual increase in energy prices should have a manageable impact on industrial activity, although energy intensive industries will be adversely affected and will need to adjust. In the longer-term energy price reforms could generate significant permanent real income gains for the economy as a whole. More broadly, international experiences suggest that the likelihood of success with energy price reforms increases if the reforms are:

Inflation Dynamics in Ghana

The study sought to investigate the key factors that influence inflation dynamics in Ghana. The study found that inflation in Ghana is determined primarily by inflation persistence, reflecting price expectations, domestic food prices, petroleum prices and exchange rate. The other determinants of inflation used in this study such as money supply and world food prices weakly affect domestic inflation. The study also recommended that anchoring inflation expectations and managing exchange rate misalignment remains key policy strategies in any effort and attempt by the monetary authorities to achieving and maintaining price stability in the country coupled with moderating the negative effects of other inflation determining factors.

Securing Monetary and Financial Stability: Why Canada Needs a Macroprudential Policy Framework

Canada’s inflation-target agreement between the government and the Bank of Canada is up for renewal by 31 December 2016. In the aftermath of the 2008-2009 global financial crisis, one of the critical issues for consideration is the integration of price and financial stability in the conduct of policy. This Commentary addresses the importance for the conduct of monetary policy of having a separate coherent framework for macroprudential policy – designed to prevent the build-up of systemic, or system-wide, financial risks. A key lesson of the financial crisis was the insufficient attention being paid to these risks and their consequences for the economy. The importance of this issue can be seen in two ways. The first relates to the interactions between monetary and macroprudential policy tools in light of concerns about rising levels of household debt. At various times, there will be situations when only one policy tool is needed, when both policies need to be used in the same direction, or when the two policies need to work in opposite directions. The second relates to the Bank’s current “risk management approach” to monetary policy. In the absence of a government framework for the active use of macroprudential tools, this approach implies that monetary policy becomes a more important line of defence against systemic risks than it needs to be, with the risk of sub-optimal monetary policy outcomes. Our conclusions are threefold: • Canada’s 2 percent inflation target and policy framework has served the economy well, most importantly in anchoring inflation expectations; • over the past two years, Canadian monetary policy would have been better placed to combat low inflation and excess capacity had macroprudential policies been openly geared to reducing the systemic risks associated with rising household indebtedness and housing prices; and • drawing on best practices, the government needs to elevate macroprudential policies by establishing clear objectives, tools and lines of responsibility and accountability. The payoff for Canadians cannot be overstated: greater assurance of both financial stability, as a result of assigned responsibility for macroprudential policy, and monetary stability, as a result of the Bank of Canada’s continued primary focus on inflation and output stabilization.

Understanding High Inflation Trend in India

Stylized Indian facts and structural features are consistent with an elastic aggregate supply, subject to cost push. A variety of time series tests support this against an alternative hypothesis of inelastic supply. Mechanisms that propagate relative price changes into the price level include sector bottlenecks and governance failures. The first best policy response to a temporary supply shock is to shift down the supply curve by neutralizing mechanisms that propagate supply shocks, while avoiding too large a demand contraction. A standard monetary tightening to anchor inflation expectations requires a large growth sacrifice. Backward-looking price setting in some Indian firms reduces the required intensity of tightening. JEL Classification: E31, E52, E62, O23

Inflation, deflation, and uncertainty: What drives euro-area option-implied inflation expectations, and are they still anchored in the sovereign debt crisis?

We tackle two questions in this paper: In the sovereign debt crisis, what moves the euro-area inflation outlook, and has the firm anchoring of medium to long-term inflation expectations been affected? We try to answer these questions by looking at option-implied probability density functions of future inflation. Deriving densities from a new data set on options on the euro-area harmonised index of consumer prices (excluding tobacco) provides us with the full distribution of inflation expectations, including uncertainty and asymmetry of market participants' beliefs about the inflation outlook. The daily data set allows us to analyse the effects of monetary policy announcements and macro news in a time-varying event study framework despite the short sample period from 2009 to 2013. Due to renewed fears of deflation, we compare option-implied and statistical density functions to gain insight into deflation risk. Inflation expectations show a decreasing mean but growing uncertainty, especially since the intensification of the sovereign debt crisis in mid-2011. Around the same time, the influence of monetary policy announcements on inflation expectations across all horizons diminished. Tail events such as deflation, although still contained, have become more probable. The impact of macroeconomic news on inflation probabilities has overall decreased and shifted towards countries more affected by the crisis. This paper's results regarding the anchoring of inflation expectations are twofold: The mean and low sensitivity to actual news speak for anchored inflation expectations, whereas the growing uncertainty reveals market participants' concerns about possible extreme inflation or deflation outcomes in the future.

Global Food Prices and Domestic Inflation: Some Cross-Country Evidence

This paper provides a broad brush look at the impact of fluctuations in global food prices on domestic inflation in a large group of countries. For advanced economies, we find that these fluctuations have played a significant role over the period from 1960 to the present, but the impact has declined over time and become less persistent. We also find that the more recent global food price shocks occurred in the 2000s had a much bigger impact on emerging than on advanced economies. This larger impact could reflect the larger share of food in the consumption baskets in emerging economies on average than in advanced economies, and less anchored inflation expectations in emerging economies than in advanced economies.

Inflation Targeting Does Not Anchor Inflation Expectations: Evidence from Firms in New Zealand

Using a new survey of firm managers, we investigate whether inflation expectations in New Zealand are anchored or not. In spite of 25 years of inflation targeting by the Reserve Bank of New Zealand, firm managers display little anchoring of such expectations. We document this finding along a number of dimensions. Managers are unaware of the identities of central bankers or of central banks’ objectives, and they are generally poorly informed about recent inflation dynamics. Their forecasts of future inflation reflect high levels of uncertainty and are extremely dispersed, and they are volatile along both short-run and long-run horizons. Similar results can be found for the United States using currently available surveys.

Global Food Prices and Domestic Inflation: Some Cross-Country Evidence

This paper provides a broad brush look at the impact of fluctuations in global food prices on domestic inflation in a large group of countries. For advanced economies, we find that these fluctuations have played a significant role over the period from 1960 to the present, but the impact has declined over time and become less persistent. We also find that the more recent global food price shocks occurred in the 2000s had a much bigger impact on emerging than on advanced economies. This larger impact could reflect the larger share of food in the consumption baskets in emerging economies on average than in advanced economies, and less anchored inflation expectations in emerging economies than in advanced economies.

Shock from Graying: Is the Demographic Shift Weakening Monetary Policy Effectiveness

AbstractThere is mounting evidence that in advanced economies, changes in monetary policy have a more benign impact on the economy—given better anchored inflation expectations and inflation being less responsive to variation in unemployment—compared with the past. We examine another aspect that could explain this empirical finding, namely the demographic shift to an older society. The paper first clarifies potential transmission channels that could explain why monetary policy effectiveness may moderate in graying societies. Then, using Bayesian estimation techniques for the USA, Canada, Japan, the UK and Germany, a weakening of monetary policy effectiveness over time with regard to unemployment and inflation is confirmed. After proving the existence of a panel co‐integration relationship between ageing and a weakening of monetary policy, the study uses dynamic panel ordinary least squares techniques to attribute this weakening of monetary policy effectiveness to demographic changes. The paper concludes with policy implications. Copyright © 2014 John Wiley & Sons, Ltd.