Firmly-anchored inflation expectations are widely viewed as playing a central role in the successful conduct of monetary policy. This paper presents estimates of trend inflation, based on information contained in survey expectations, the term structure of interest rates, and realized inflation rates. My application combines a variety of data sources at the monthly frequency and it can flexibly handle missing data arising from infrequent observations and limited data availability. In order to assess whether inflation expectations are anchored, uncertainty surrounding future changes in trend inflation-measured by a time-varying volatility of trend shocks-is estimated as well. Not surprisingly, the estimates suggest that trend inflation in the U.S. rose and fell again over the 1970s and 1980s, accompanied by increases in uncertainty. Considering the recent crisis, full-sample estimates of trend inflation fell quite a bit, but not too dramatically. In contrast, real-time estimates recorded sizeable increases of trend uncertainty during the crisis of 2007/2008, which have abated since then.
There is widespread evidence of excess return predictability in financial markets. A potential explanation is that investors make expectational errors that are predictable. To examine this issue, we use data on survey expectations of market participants in the stock market, the foreign exchange market, and the bond and money markets in various countries. We find systematic evidence of predictable expectational errors across markets, sample periods and countries. Moreover, the predictability of expectational errors coincides with the predictability of excess returns: when a variable predicts expectational errors in a given market, it typically predicts the excess return as well. We conclude that that predictable expectational errors play a key role in understanding excess return predictability.
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This paper studies the joint dynamics of real time U.S. inflation and the mean inflation predictions of the Survey of Professional Forecasters (SPF) on a 1968Q4 to 2017Q2 sample. The joint data generating process (DGP) is an unobserved components (UC) model of inflation and a sticky information (SI) prediction mechanism for SPF inflation predictions. We add drifting gap inflation persistence to a UC model that already has stochastic volatility (SV) afflicting trend and gap inflation. Another innovation puts a timevarying frequency of inflation forecast updating into the SI-prediction mechanism. The joint DGP is a nonlinear state space model (SSM). We estimate the SSM using Bayesian tools grounded in a Rao-Blackwellized auxiliary particle filter, particle learning, and a particle smoother. The estimates show (i) longer horizon average SPF inflation predictions inform estimates of trend inflation, (ii) gap inflation persistence is pro-cyclical, and SI inflation updating is frequent before the Volcker disinflation, and (iii) subsequently, trend inflation and its SV fall, gap inflation persistence turns countercyclical, and SI inflation updating becomes infrequent. AbstractThis paper studies the joint dynamics of real time U.S. inflation and the mean inflation predictions of the Survey of Professional Forecasters (SPF) on a 1968Q 4 to 2017Q 2 sample. The joint data generating process (DGP) is an unobserved components (UC) model of inflation and a sticky information (SI) prediction mechanism for SPF inflation predictions. We add drifting gap inflation persistence to a UC model that already has stochastic volatility (SV) afflicting trend and gap inflation. Another innovation puts a time-varying frequency of inflation forecast updating into the SI-prediction mechanism. The joint DGP is a nonlinear state space model (SSM). We estimate the SSM using Bayesian tools grounded in a Rao-Blackwellized auxiliary particle filter, particle learning, and a particle smoother. The estimates show (i) longer horizon average SPF inflation predictions inform estimates of trend inflation, (ii) gap inflation persistence is pro-cyclical, and SI inflation updating is frequent before the Volcker disinflation, and (iii) subsequently, trend inflation and its SV fall, gap inflation persistence turns counter-cyclical, and SI inflation updating becomes infrequent. JEL Classification Numbers: E31, C11, C32.
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