Has the Anchoring of Inflation Expectations Changed in the United States during the Past Decade?

Abstract

M onetary policy has changed dramatically in the United States over the past decade, with potential implications for investors' inflation expectations. During the financial crisis and Great Recession of 2007-09, the Federal Reserve's conventional policy tool, the nominal short-term interest rate, was constrained by its effective lower bound. At the time, monetary policy makers were concerned the U.S. economy might slip into a deflationary trap similar to Japan's during the period of 1999-2003. As a result, the Fed responded aggressively to stabilize the economy through multiple rounds of large-scale asset purchases (LSAPs) and forward guidance on the future interest rate. In addition, the Federal Open Market Committee (FOMC) adopted a formal inflation target at its meeting in January 2012, emphasizing that "communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored." Well-anchored inflation expectations are a key measure of successful monetary policy, because in the long run, inflation is mainly determined by monetary policy. Inflation expectations drifting away from the central bank's implicit or explicit inflation targets can generate highly inflationary or disinflationary episodes. For example, businesses expecting a higher inflation rate may increase current prices to offset Has the Anchoring of Inflation Expectations Changed in the United States during the Past Decade?

A New Approach to Integrating Expectations into VAR Models

“…Bundick and Smith (2018) find that financial market measures of inflation compensation became better anchored sometime between 2009 and 2012, which spans the period between the addition of longer-run inflation to the FOMC's quarterly Summary of Economic Projections and the adoption of a 2% longer-run inflation target. Doh and Oksol (2018) find similar evidence that professional forecasters' long-term inflation expectations showed signs of better anchoring beginning around 2010. Detmeister et al (2015) also find that the FOMC's announcement of an explicit inflation objective led professional forecasters' long-run inflation expectations to coalesce around 2 percent.…”

Thinking Outside the Box: Do SPF Respondents Have Anchored Inflation Expectations?

“…First, despite the steadiness of the median 10-year forecast, individual SPF respondents are not anchored to the Fed's target (a finding consistent with Binder (2017b) and Coibion et al (2019)). Second, notable progress has been made in expectations becoming anchored (in keeping with Doh and Oksol (2018)).…”

Did the Federal Reserve Anchor Inflation Expectations Too Low?

“…6 Using a different approach, Doh and Oksol (2018) also find evidence that long-term inflation expectations became better anchored after 2010. 7 Forbes (2019) more formally analyzes the role that global forces have played in shaping recent U.S. inflation dynamics.…”