Long-term Inflation Expectations Research Articles

(Mis)Alignment between observed and expected monetary policy: The case of Brazil

The economic agents’ perception of the monetary policy might not coincide with the central bank conduct. We investigate this issue by using both actual and expected data identified by professional forecasters for Brazil, an emerging economy that has long adopted the inflation-targeting regime. We estimate observed, expected, and forward-looking interest rate rules, apply Full-Information Rational Expectations (FIRE) tests, assess restrictions implied by models of information rigidity, and perform several robustness checks. The estimated policy rules respond to inflation deviations and output gap according to theoretical grounds. Professional forecasters, however, do not believe in aggressiveness to fight inflation in longer forecasting horizons, while FIRE tests unveil information rigidity in the short run. There is a misalignment between the Central Bank practice and the private agents’ perception of the monetary policy in the long but not in the short run, suggesting unanchored long-term inflation expectations.

A Financial New Keynesian Model

This paper solves a standard New Keynesian model in terms of risk-neutral expectations and estimates it using a cross-section of longer-dated financial assets at a single point in time. Inflation risk premia appear in the theory and cause inflation to deviate from its target on average. We re-estimate the model based on each day’s closing prices to capture high-frequency changes in the expected path of the economy. Our estimates show that financial markets reacted to the post-COVID surge in inflation with higher short-run inflation expectations, an increase in the inflation risk premium, and an increase in the long-run neutral real rate, 𝑟∗, while long-term inflation expectations remained well anchored. Our model produces long term inflation forecasts that outperform several standard alternative measures.

The Federal Reserve's Interest Rate Policy and Its Impact Against a Background of Inflation and High Unemployment Rate

This research adopts various economic data sources to investigate the effects of Federal Reserve (Fed) policies on the US economy. Specifically, the study focuses on labor market flows, short and long-term inflation expectations, and interest rates from 1960 to 2023. The findings suggest that over the past three decades, the Fed has artificially manipulated interest rates to curb long-term increases in unemployment. In this regard, this paper discusses the Impact of Business Financing and Costs, Labor Costs and Prices, Impact on Market Supply and Demand on interest rate changes from three perspectives. This study delves into detailed micro data on job vacancy rates and average earnings coefficients for different workers. By analyzing these factors and interest rate data, the paper argues that there is a strong correlation between employment trends and the Federal Reserve's monetary policy. Based on the data, the study projected that even if long-term inflation expectations remained stable, underlying inflation would still be half a percentage point above its long-term trend by the end of 2023. Overall, the paper provides valuable insight into the complex relationship between Fed policy, employment trends, and inflation in the U.S. economy.

Long-term inflation expectations and monetary policy in the euro area before the pandemic

Survey-based long-term inflation expectations in the euro area reached historically low levels at the end of 2019. A structural VAR analysis shows that the decline in long-term expectations exerted a downward pressure on inflation during the 2013–14 disinflation and in 2019. Counterfactual simulations show that the decrease in inflation would have been larger and output would have declined had the European Central Bank not responded to the fall in expectations. A small New Keynesian model, in which the private sector's estimate of the inflation target varies with inflation, can rationalise the VAR evidence.

Monetary Policy and Bond Prices with Drifting Equilibrium Rates

AbstractWe study the drift and cyclical components in U.S. Treasury bonds. We find that bond yields are drifting because they reflect the drift in monetary policy rates. Empirically, modeling the monetary policy drift using demographics and productivity trends, plus long-term inflation expectations, leads to cyclical deviations of bond prices from their drift that predict bond returns in- and out-of-sample. These bond cycles can be interpreted as term premia or/and temporary deviations from rational expectations in a behavioral framework. Through the lens of our model, we detect a significant role of the latter in determining the cyclical properties of yields with short maturities.

THE IMPACT OF EXCHANGE RATE SHOCKS ON INFLATION EXPECTATIONS IN TÜRKIYE

This study examines the impact of macroeconomic shocks, represented by exchange rate volatility, on inflation expectations. Using data for the period 2006:04-2023:11 and the structural VAR method, the analysis examines the direct effect of macroeconomic shocks on short-term inflation expectations and the indirect effect on long-term inflation expectations. The results have shown that macroeconomic shocks have a direct effect on short-term inflation expectations and an indirect effect on long-term inflation expectations via short-term inflation expectations, which is referred to in the literature as the pass-through effect and shows that the uncertainty channel is active. Our results suggest that the Central Bank of the Republic of Türkiye (CBRT), which wants to keep short- and long-term inflation expectations under control, should also take into account macroeconomic shocks, represented by exchange rate shocks, when determining policy instruments.

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)

Inflation Expectations, Inflation Target Credibility, and the COVID-19 Pandemic: Evidence from Germany.

Using the exact wording of the European Central Bank's definition of price stability, we started a representative online survey of German citizens in January 2019 that is designed to measure long-term inflation expectations and the credibility of the inflation target. Our results indicate that credibility has decreased in our sample period, particularly in the course of the deep recession implied by the Covid-19 pandemic. Interestingly, even though inflation rates in Germany have been clearly below 2% for several years, credibility has declined mainly because Germans increasingly expect that inflation will be much higher than 2% over the medium term. We investigate how inflation expectations and the impact of the pandemic depend on personal characteristics including age, gender, education, and politicalattitude.

COMPARATIVE ANALYSIS OF MONETARY POLICY OF EASTERN EUROPEAN COUNTRIES AND GEORGIA

Relevance of the study: Central banks exert their influence on the economy by changing the money supply using appropriate instruments in a free financial market. The combination of these tools gives us the operational framework of the National Bank. Aim of the research: to study the instruments (operational framework) of monetary policy regulation of Georgia, Moldova and Montenegro, to identify problems and to find ways to solve them. Research Methods: Use of comparative analysis method based on the database of the National Bank of Georgia, Geostat and the International Monetary Fund. The impact of Georgia's monetary policy regime and instruments on the country's macroeconomic indicators, such as inflation and GDP growth rates. Analysis of the macroeconomic parameters, monetary policy regime and regulatory instruments of Moldova and Montenegro. Comparative analysis of the operational framework of the monetary policy of Georgia, Moldova and Montenegro and ways to solve the identified problems. Monetary policy only changes the future outlook for inflation, and central banks respond to one-time exogenous factors when those factors are so strong that they reflect long-term inflation expectations. Therefore, further tightening of monetary policy (already tightened) will lead to a slowdown in GDP growth and unemployment. According to current forecasts, the inflation rate in 2022 will remain high. Given that the role of temporary and exogenous factors in inflation remains to be determined, while monetary policy is still in a tightening phase, the National Bank has decided to maintain the current level of interest rates. However, in the face of strong supply shocks, the threat of further growth in inflation is still relevant. Against the background of these inflationary risks, a tightening of monetary policy or an increase in interest rates is probably still expected.

The anchoring of long-term inflation expectations of consumers: insights from a new survey

Abstract We provide new evidence on the level and probability distribution of consumers’ long-term expectations of inflation in the euro area and the Netherlands, using a new monthly representative Dutch survey before and during the COVID-19 pandemic. We find that consumers’ expectations of euro area and Dutch inflation 10 years ahead have not been well anchored at the ECB’s inflation aim of below, but close to 2%. Median expectations have remained elevated above the European Central Bank's (ECB) inflation aim throughout the pandemic. Moreover, individual probability distributions show that expected probabilities of higher inflation (4% or higher) have continuously been larger than those of lower inflation (0% or lower). While policymakers are currently concerned about a possible de-anchoring of inflation expectations on the downside, our results suggest that from a consumer’s point of view de-anchoring of long-term inflation expectations is mainly due to expected high inflation rather than low inflation.

The Challenges of Inflation in Europe and the US

Inflationary pressures and uncertainties related to the severity and duration of the coronavirus pandemic have been growing steadily in the last year. Different approaches to supporting labour force participation in Europe and the United States have led to different inflationary outcomes. In addition, the Russian war against Ukraine, which began on 24 February, has provided a definitive answer to questions about whether rising inflation is just temporary. The sharp increase in already volatile food and energy prices is presenting monetary policymakers with new challenges. The authors in this Forum consider how to respond to rising inflation, discuss why inflation is so hard to predict and examine whether long-term inflation expectations have de-anchored.

Conducting Causal Analysis by Means of Approximating Probabilistic Truths.

Simple SummaryThe current paper develops a probabilistic theory of causation and suggests practical routines for conducting causal inference applicable to new machine learning methods that have, so far, remained relatively underutilized in this context.The current paper develops a probabilistic theory of causation using measure-theoretical concepts and suggests practical routines for conducting causal inference. The theory is applicable to both linear and high-dimensional nonlinear models. An example is provided using random forest regressions and daily data on yield spreads. The application tests how uncertainty in short- and long-term inflation expectations interacts with spreads in the daily Bitcoin price. The results are contrasted with those obtained by standard linear Granger causality tests. It is shown that the suggested measure-theoretic approaches do not only lead to better predictive models, but also to more plausible parsimonious descriptions of possible causal flows. The paper concludes that researchers interested in causal analysis should be more aspirational in terms of developing predictive capabilities, even if the interest is in inference and not in prediction per se. The theory developed in the paper provides practitioners guidance for developing causal models using new machine learning methods that have, so far, remained relatively underutilized in this context.

Long-Term Inflation Expectations and Monetary Policy

Long-Term Inflation Expectations and Monetary Policy

The impact of guidance, short-term dynamics and individual characteristics on firms’ long-term inflation expectations

Long-term inflation expectations are an essential element in the transmission of a central bank’s monetary policy. However, it is not fully understood how these long-term inflation expectations behave, as well as whether and how they can be managed. In this paper, we shed light on possible drivers of long-term inflation expectations of firms using information from the Swiss National Bank (SNB) regional network survey. We extended the standard survey with questions to test whether the long-term inflation expectations of firms can be actively influenced by providing information regarding the central bank’s objective, its past performance and long-term average inflation. We find that this type of information, which we call guidance: a) can influence the long-term inflation expectations of firms to a certain extent; and b) surprisingly, it does not have an impact on the uncertainty surrounding the expectations. However, c) uncertainty itself is positively correlated with the level of inflation expectations, and respondents who are more uncertain place greater weight on the information that they receive. Furthermore, d) short-term inflation expectations; e) the individual characteristics of the firms related to prices; and f) a large unexpected shock, in our case, a large shock to the exchange rate, can help to explain the behaviour of long-term inflation expectations.

Monetary reforms and inflation expectations in Japan: Evidence from inflation-indexed bonds

We assess the impact of news concerning recent Japanese monetary reforms on long-term inflation expectations using an arbitrage-free term structure model of nominal and real yields. Our model accounts for the value of deflation protection embedded in Japanese inflation-indexed bonds issued since 2013, which is sizable and time-varying. Our results suggest that Japanese long-term inflation expectations have remained positive despite extensive spells of deflation, leaving inflation risk premia mostly negative during this period. Moreover, adjusting for deflation protection demonstrates that market responses to policy changes were not as inflationary as they appear under standard modeling procedures. Consequently, the reforms were less “disappointing” than is widely perceived.

Inflation trends in Asia: implications for central banks

Abstract This article shows that trend inflation estimation offers crucial insights for the analysis of inflation dynamics and long-term inflation expectations. Focusing on the 12 largest Asian economies, a sample comprising both advanced and emerging economies and different monetary policy regimes, we show that trend inflation analysis can help explain the different impact of the disinflationary shocks across countries. Among countries with inflation below target in recent years, in those with trend inflation low but constant (Australia, New Zealand) low inflation may be lasting, but temporary, while those in which trend inflation has declined (South Korea, Thailand) risk low inflation to become entrenched and a de-anchoring of expectations. Countries like India, Philippines, and Indonesia instead experienced a moderation in inflation and lower trend inflation, while others (China, Taiwan, Hong Kong SAR, Malaysia) were impacted very mildly. That diverse international evidence offers important insights for central banks worldwide.

Long-term inflation expectations and the transmission of monetary policy shocks: Evidence from a SVAR analysis

This paper investigates the role of long-term inflation expectations for the monetary transmission mechanism and the conduct of monetary policy in a structural VAR framework. In contrast to earlier studies, we find that U.S. long-term inflation expectations respond significantly to a monetary policy shock. In line with a re-anchoring channel of monetary policy, long-term inflation expectations play an important role for the transmission of monetary policy shocks to the rate of inflation. Structural scenario analysis suggests that the response of monetary policy to expectations shocks contributes to the stabilization of inflation and unemployment.

Does New Zealand's inflation target anchor long-term expectations?

A claimed benefit of an inflation target is that it provides an anchor for long-term inflation expectations. We evaluate this by using survey-based inflation expectations data for New Zealand to assess whether forecasts for different horizons systematically converge to the RBNZ's target. We find evidence of this from the aggregated expectations data, and for most individual professional economists and financial sector forecasters in our sample. However, the evidence from forecasters in other sectors is mixed. In particular, those from the business community appear more focussed on the RBNZ's inflation track record. This could contribute to episodes of persistently low inflation.

Anchored or de-anchored? That is the question

Using a variety of approaches, this paper shows that long-term inflation expectations have de-anchored from the ECB’s inflation aim. The long-term expectations reported in the ECB Survey of Professional Forecasters have not regained the levels that prevailed before the 2013-14 disinflation. Long-term expectations have also become sensitive to short-term expectations and to negative surprises to inflation. Forecasters who participated in most of the survey rounds were highly sensitive to short-term developments in inflation.

Changes in inflation compensation and oil prices: short-term and long-term dynamics

This paper investigates the relationship between changes in euro area short-term and long-term market-based inflation expectations from January 2005 to September 2018, also devoting special attention to the relevance of the oil market. The full sample is split into three subsets related to different economic and financial landscapes. To model the conditional mean and the variance–covariance structure, a VAR-CCC-GARCH specification with oil effects in the volatility proves to be a preferable approach compared to other multivariate GARCH models. In general, the conditional correlation between changes in short-term and long-term inflation compensation appears as constant and relatively low in each subset, though increasing since mid-2014. Furthermore, there are no signs of fundamental deviations in how changes in short-term inflation expectations affect changes in longer-term expectations and vice versa. There is evidence that changes in short-term inflation expectations tend to respond to the movements of oil prices over time, while changes in longer-term ones started responding to crude dynamics after mid-2008. On the whole, these findings are relevant for analysts, investors and especially for the policymakers who charged with ensuring price stability.