Long-run Inflation Expectations Research Articles

Monetary policy & anchored expectations—An endogenous gain learning model

Monetary policy is analyzed in a model with a potential unanchoring of inflation expectations. The degree of unanchoring is given by how sensitively the public’s long-run inflation expectations respond to inflation surprises. I find that optimal policy moves the interest rate aggressively when expectations unanchor, allowing the central bank to accommodate inflation fluctuations when expectations are well-anchored. Furthermore, I estimate the model-implied unanchoring process. The data suggest that unanchoring is nonlinear and asymmetric: expectations respond more sensitively to large or downside surprises than to smaller or upside ones.

Did the Federal Reserve Break the Phillips Curve? Theory & Evidence of Anchoring Inflation Expectations

Abstract In a macroeconomic model with drifting long-run inflation expectations, the anchoring of inflation expectations manifests in two testable predictions. First, expectations about inflation far in the future should no longer respond to news about current inflation. Second, better anchored inflation expectations weaken the relationship between unemployment and inflation, flattening the reduced-form Phillips curve. We evaluate both predictions and find that the Federal Reserve's communication of a numerical inflation objective, first through its Summary of Economic Projections and later through the announcement of a 2 percent target in 2012, better anchored inflation expectations. Moreover, inflation expectations in the United States have remained anchored amid the volatility of the COVID-19 pandemic. In contrast, similar analysis reveals no evidence of anchoring in Japan despite the adoption of a numerical inflation target.

What to target? Insights from a lab experiment

This paper compares alternative monetary policy regimes within a controlled lab environment, where groups of participants are tasked with repeatedly forecasting inflation in a simple macroeconomic model featuring only the dynamics of interest rates, inflation and inflation expectations. Average-inflation targeting can replicate the price path observed under price-level targeting in the presence of disinflationary shocks and enable subjects to coordinate on simple heuristics that reflect the concern of the central bank for past inflation gaps. However, this depends on the exact specification of the policy rule. In particular, if the central bank considers more than two lags, subjects fail to form expectations that are consistent with the monetary policy rule, which results in greater inflation volatility. Reinforcing communication around the target helps somewhat anchor long-run inflation expectations.

Anchored Inflation Expectations

We develop a theory of low-frequency movements in inflation expectations, and use it to interpret joint dynamics of inflation and inflation expectations for the United States and other countries over the postwar period. In our theory, long-run inflation expectations are endogenous. They are driven by short-run inflation surprises, in a way that depends on recent forecasting performance and monetary policy. This distinguishes our theory from common explanations of low-frequency properties of inflation. The model, estimated using only inflation and short-term forecasts from professional surveys, accurately predicts observed measures of long-term inflation expectations and identifies episodes of unanchored expectations. (JEL D83, D84, E12, E23, E31, E37, E52)

The Role of Inflation Targeting in Anchoring Long-Run Inflation Expectations: Evidence from India

The Role of Inflation Targeting in Anchoring Long-Run Inflation Expectations: Evidence from India

Monetary policy and the term structure of inflation expectations with information frictions

I estimate how the term structure of inflation expectations in the United States responds to monetary policy shocks from 1982 to 2019. Studying the entire term structure uses all available data and allows me to examine whether forecasts at different horizons respond differently to the same shock, which may influence bond pricing, investment decisions, and the term structures of real and nominal interest rates. Survey forecasts of inflation (taken from the Survey of Professional Forecasters) are available at many horizons, but combining these in a consistent way is challenging because of information frictions and the number of available forecasts. I extend the unobserved components model to include additional covariates and allow for information frictions, a combination of features that allows me to identify the effects of monetary policy shocks, which I do using an instrumental variable. I find that a contractionary monetary policy shock twists the term structure of inflation expectations, raising short-run expectations while lowering long-run expectations, which suggests that long-run expectations are not well anchored. I also show that monetary policy actions taken throughout the recession beginning in 2008 propped up long-run inflation expectations from 2009 to 2014.

A new approach to assess inflation expectations anchoring using strategic surveys

We propose a new approach to assess inflation expectations anchoring using “strategic surveys.” Namely, we measure households’ revisions in long-run inflation expectations after they are presented with different economic scenarios. This approach has a causal interpretation and maps directly into policy makers concerns. We implement the method in the summer of 2019 and the spring-summer of 2021 when the anchoring of long-run inflation expectations was questioned. We find that the risk of un-anchoring was reasonably low in both periods, and that long-run inflation expectations were essentially as well anchored in August 2021 as in July 2019, before the Covid-19 pandemic.

The Slope of the Phillips Curve: Evidence from U.S. States

AbstractWe estimate the slope of the Phillips curve in the cross section of U.S. states using newly constructed state-level price indices for nontradeable goods back to 1978. Our estimates indicate that the slope of the Phillips curve is small and was small even during the early 1980s. We estimate only a modest decline in the slope of the Phillips curve since the 1980s. We use a multiregion model to infer the slope of the aggregate Phillips curve from our regional estimates. Applying our estimates to recent unemployment dynamics yields essentially no missing disinflation or missing reinflation over the past few business cycles. Our results imply that the sharp drop in core inflation in the early 1980s was mostly due to shifting expectations about long-run monetary policy as opposed to a steep Phillips curve, and the greater stability of inflation between 1990 and 2020 is mostly due to long-run inflation expectations becoming more firmly anchored.

Are long-run inflation expectations well anchored?

Many observers anticipate that the recent run-up in inflation in the United States will prove to be temporary, and annual inflation will be near the Fed’s target of 2% in 2022 and 2023. An important consideration for policymakers, however, is whether the private sector will similarly read the rise in inflation as temporary. That is, are long-run inflation expectations likely to remain anchored, or might the sharp rise in inflation cause long-run expectations to increase substantially as well?

Long-run inflation expectations in the ECB survey of professional forecasters: what do the survey responses tell us?

Research background: At the background, there are issues related to policy credibility and policy targets. For these issues, long-term forecasts can provide important information. Of course, long-term forecasts are needed also e.g. for evaluation of real returns.
 Purpose of the article: This paper tries to find out how informative the ECB Survey of Professional Forecasters data on long-term inflation prospects are from the point of view of the overall quality of the survey and on the other hand from the point of view of monetary policy credibility.
 Methods: The analysis makes use of individual forecaster level quarterly panel data for the period 1999Q1?2018Q4. Conventional panel econometrics tools are used to find out whether forecasts are sensitive to changes in actual inflation and other relevant variables.
 Findings & Value added: We find some weaknesses considering the size of the survey, the selection of the sample (more precisely the participation to the survey) and the inertial responses of forecasters which suggest that the survey values are not actively updated. Moreover, we find that towards the end of the sample period, the survey values are related to actual inflation and to short-term expectations, which is not consistent with the credibility of the official inflation target.

Inflation Expectations in the U.S.

Inflation has been below the Federal Reserve’s target for much of the past 20 years, creating worries that inflation may be deanchoring from the FOMC’s target. This paper uses a factor model that incorporates information from professional forecasters, household and business surveys, and the market for Treasury inflation protected securities (TIPS) to estimate long-run inflation expectations. These have fallen notably in the past few years (to roughly 1.9 percent for CPI inflation, well below the FOMC’s target). It appears that, even before the covid recession, the private sector viewed the economy as likely to suffer from persistent headwinds to inflation.

Did the Federal Reserve Break the Phillips Curve? Theory and Evidence of Anchoring Inflation Expectations

In a macroeconomic model with drifting long-run inflation expectations, the anchoring of inflation expectations manifests in two testable predictions. First, expectations about inflation far in the future should no longer respond to news about current inflation. Second, better-anchored inflation expectations weaken the relationship between unemployment and inflation, flattening the reduced-form Phillips curve. We evaluate both predictions and find that communication of a numerical inflation objective better anchored inflation expectations in the United States but failed to anchor expectations in Japan. Moreover, the improved anchoring of U.S. inflation expectations can account for much of the observed flattening of the Phillips curve. Finally, we present evidence that initial Federal Reserve communication around its longer-run inflation objective may have led inflation expectations to anchor at a level below 2 percent.

Did the Federal Reserve Break the Phillips Curve? Theory and Evidence of Anchoring Inflation Expectations

In a macroeconomic model with drifting long-run inflation expectations, the anchoring of inflation expectations manifests in two testable predictions. First, expectations about inflation far in the future should no longer respond to news about current inflation. Second, better anchored inflation expectations weaken the relationship between unemployment and inflation, flattening the reduced-form Phillips curve. We evaluate both predictions and find that communication of a numerical inflation objective better anchored inflation expectations in the US but failed to anchor expectations in Japan. Moreover, the improved anchoring of US inflation expectations can account for much of the observed flattening of the Phillips curve. Finally, we present evidence that initial Federal Reserve communication around its longer-run inflation objective may have led inflation expectations to anchor at a level below 2 percent.

How Robust Are Makeup Strategies to Key Alternative Assumptions?

We analyze the robustness of makeup strategies—policies that aim to offset, at least in part, past misses of inflation from its objective—to alternative modeling assumptions, with an emphasis on the role of inflation expectations. We survey empirical evidence on the behavior of shorter-run and long-run inflation expectations. Using simulations from the FRB/US macroeconomic model, we find that makeup strategies can moderately offset the real effects of adverse economic shocks, even when much of the public is uninformed about the monetary strategy. We also discuss the robustness of makeup strategies to alternative assumptions about the slope of the Phillips curve and the (mis)perception of economic slack.

Ambiguity, Monetary Policy and Trend Inflation

ABSTRACT Allowing for ambiguity about the behavior of the policymaker in a simple New-Keynesian model gives rise to wedges between long-run inflation expectations, trend inflation, and the inflation target. The degree of ambiguity we measure in Blue Chip survey data helps explain the dynamics of long-run inflation expectations and the inflation trend measured in the US data. Ambiguity also has implications for monetary policy. We show that it is optimal for policymakers to lean against the households’ pessimistic expectations, but also document the limits to the extent the adverse effects of ambiguity can be undone.

Presidential Antagonism and Central Bank Credibility

This paper uses an online survey experiment to study how President Trump's criticism of the Federal Reserve may affect consumers' long-run inflation expectations, confidence in the Fed, and responsiveness to information about inflation. A random subset of respondents view one of President Trump's critical tweets about the Fed, or the tweet plus a Washington Post article discussing the President as a threat to the Fed's independence. All respondents provide long-run inflation forecasts, before and after receiving information about past inflation and the Fed's inflation target. Finally, respondents rate their confidence in the President and the Fed. Respondents who view the tweet or tweet plus article have final long-run inflation forecasts that are farther from the Fed's target after exposure to information about the Fed's target and recent inflation. Exposure to the tweet plus news article has a polarizing effect on confidence, increasing the share of respondents with high confidence in either the Fed or the President.

Inflation Expectations in the U.S.: Linking Markets, Households, and Businesses

Inflation has been below the Federal Reserve's target for much of the past 20 years, creating worries that inflation may be deanchoring from the FOMC's target. This paper uses a factor model that incorporates information from professional forecasters, household and business surveys, and the market for Treasury inflation protected securities (TIPS) to estimate long-run inflation expectations. These have fallen notably in the past few years (to roughly 1.9 percent for CPI inflation, well below the FOMC's target). It appears that, even before the covid recession, the private sector viewed the economy as likely to suffer from persistent headwinds to inflation.

Long-run inflation expectations in the shrinking upper tail

Consumer inflation expectations are highly disperse, with some households reporting very high inflation forecasts. In recent years, disagreement in longer-run inflation expectations has fallen, reflecting compression in the upper part of the distribution. The 75th percentile of the distribution of longer-run inflation forecast has fallen 0.21 percentage points per year since 2012 and is at an all-time low. I show that the decline in long-run inflation expectations at the upper end of the distribution seems to reflect improvement in consumers’ general economic sentiment, rather than stronger anchoring of inflation expectations.

Long-Run Inflation Expectations in the Shrinking Upper Tail

Consumer inflation expectations are highly disperse, with some households reporting very high inflation forecasts. In recent years, disagreement in longer-run inflation expectations has fallen, reflecting compression in the upper part of the distribution. The 75th percentile of the distribution of longer-run inflation forecast has fallen 0.21 percentage points per year since 2012 and is at an all-time low. I show that the decline in long-run inflation expectations at the upper end of the distribution seems to reflect improvement in consumers' general economic sentiment, rather than stronger anchoring of inflation expectations.

Household Informedness and Long-Run Inflation Expectations: Experimental Evidence

This paper uses an experiment embedded in a survey to analyze the response of consumers' long-run inflation expectations to information about the Federal Reserve's inflation target and a graph and summary of past inflation. On average, respondents revise forecasts toward the 2% target with either information treatment, and both forecast uncertainty and heterogeneity decline with the treatments, but remain substantial. Since the information in the treatments is publicly available, these findings are consistent with models of imperfect information in which agents do not fully and continually update their information sets or incorporate all available information into their expectations.