The Anchoring of Inflation Expectations in the Short and in the Long Run

Abstract

This paper introduces structural VAR analysis as a tool for investigating the anchoring of inflation expectations. We show that U.S. consumers' inflation expectations are anchored in the long run because macro-news shocks are long-run neutral for long-term inflation expectations. The identification of structural shocks helps to explain why inflation expectations deviate from the central bank's target in the short run. Our results indicate that the recent decline of long-term inflation expectations does not result from deanchoring macro-news but can be attributed to downward adjustments of consumers' expectations about the central bank's inflation target.

The anchoring of inflation expectations in time and frequency domains

“…Although short-and long-term inflation expectations of both groups show downward trends after 2014, no significant relationship is demonstrated between these two time series. The result is consistent with Nautz et al (2016), implying that the decrease in long-term inflation expectations observed in Figure 1 can be attributed to downward adjustments of consumers' expected or perceived inflation targets.…”

“…This may to a certain extent explain the change in the lead-lag relationships between consumers' short-and long-term inflation expectations. Similar to the crisis period, the deanchoring of long-term inflation expectations is additionally observed in the period of 1993-1995, during which the U.S. was in turbulent times with the volatility of inflation expectations being high (Nautz et al, 2016). For high scales, relatively stable relationships emerge before 1997 and after 2006, with arrows pointing to the southeast.…”

“…They confirm the de-anchoring of inflation expectations driven by the outbreak of the crisis and indicate that inflation expectations have not been re-anchored ever since. Nautz et al (2016) adopt the structural VAR analysis and show that the long-term consumers' inflation expectations are anchored because macro-news shocks are long-run neutral in the U.S. Their findings indicate that the recent decline in long-term inflation expectations can be attributed to downward adjustments of consumers' expectations regarding the central bank's inflation target rather than a result of the de-anchoring of inflation expectations. Following Nautz and Strohsal (2015), Nautz et al (2017) apply multiple endogenous break point tests to examine the de-anchoring and reanchoring of inflation expectations in the euro area.…”

“…In the case of consumers, we consider inflation expectations covering the period of 1990/04 to 2017/03 (monthly data), which includes the financial crisis and the current low inflation regime. The Survey of Consumer Attitudes and Behavior conducted by the University of Michigan Survey Research Center provides a unique set of monthly data on one-year ahead (short-term) and 5-10 years ahead (long-term) annual inflation expectations (Nautz et al, 2016). Because of the increased economic uncertainty and unconventional monetary policy measures implemented since the Lehman Brothers collapse, we pay special attention to possible changes in anchoring inflation expectations over the last few years.…”

“…According to the results of multiple endogenous break tests provided by Nautz and Strohsal (2015), inflation expectations have not been re-anchored ever since in the U.S. Nevertheless, news-regressions investigate the anchoring of inflation expectations in a very short run, thus making the results tend to exaggerate the degree of deanchoring if the estimated response to news actually dies out quickly (Nautz, Net sunajev & Strohsal, 2016). This paper studies whether short-term inflation expectations feed into long-term inflation expectations from a time-frequency view and contributes to the previous literature as follows.…”