The Soft Tyranny of Inflation Expectations

Abstract

The degree of anchoring of inflation expectations is a key determinant of outcomes in all modern macroeconomic models, inspired by the experience of the 1970s. For monetary policy‐making today, however, the sensitivity and relevance of measured inflation expectations is more questionable. The British economy, beset by a series of significant shocks in 2008–11, while operating an inflation targeting regime, provides a case with which to explore these issues. Five conclusions emerge given current monetary and economic structures: reliable forecasts for domestically generated inflation can be made taking inflation expectations as anchored; movements in measured short‐term inflation expectations are uninformative for forecasts; financial markets can distinguish between increased economic uncertainty and uncertainty about monetary credibility; real wages do not automatically respond to rises in household inflation expectations; monetary policy should be set in accord with the best medium‐term forecast for inflation without adjustment for inflation expectations in and of themselves.

Inflation targeting & implications of oil shocks for inflation expectations in oil-importing and exporting economies: Evidence from three Nordic Kingdoms

“…In the most recent case in the UK, Marfatia (2018) showed that future inflation expectations (derived from the bond index) play a significant role in explaining the actual inflation dynamics. Posen (2011) discussing the inflation expectation in specific to the UK (an inflation targeting regime), argued that reliable forecasts for domestically generated inflation can be made taking inflation expectations as anchored. However, the evidence on UK suggests that recent exchange rate shocks have resulted in sharp increases in inflation and weak performance of the Bank of England's inflation forecast (See, Broadbent & Policy (2017); Nasir & Simpson (2018); Haldane (2017)).…”

The Eroded Foundations of Inflation Targeting

“…But again, you cannot beat something with nothing. Some subsequent challenges to microfoundations have been made, of course, but only a few drew the link to change monetary policy design (Ball et al, 2005;Posen, 2008Posen, , 2011a. Generally, the convenience advantages of forward-looking expectations and the lack of nice alternatives let those assumptions continue to influence monetary policy analysis to the present day.…”

“…See ex ante Eggertsson and Woodford (2003) or Kuttner and Posen (2001) or Posen (2006) versus Posen (2015) ex post. Like the triumph of empirical evidence taking years to kill off monetarism in the 1980s, reality should be winning out now with respect to mindless worship of expectations (Posen, 2008(Posen, , 2011a.…”

Inflation expectations of households: do they influence wage-price dynamics in India?

“…"…Short-term inflation expectations, in practice those for one-to two-years ahead, should vary with the business cycle and shocks to the economy. Longer term inflation expectations, usually thought of as those five years out or more, are anchored if the variations in short-term expectations do not affect their level significantly…" (Posen, 2011). In the empirical literature that aims at examining either how well inflation expectations are anchored or whether inflation expectations can predict future inflation, accordingly, longer-term inflation expectations (of 5-years ahead that are less sensitive to short-term shocks to inflation) collected through survey of professional forecasters/consensus forecasts are often used, which usually validate inflation expectations as a key determinant of inflation, besides providing evidence on the extent of anchoring under different monetary policy regimes/in different countries (International Monetary Fund, 2018).…”