The time-varying degree of inflation expectations anchoring

Abstract

Well-anchored inflation expectations have become a key indicator for the credibility of a central bank's inflation target. Since the outbreak of the recent financial crisis, the existence and the degree of de-anchoring of U.S. inflation expectations have been under debate. This paper introduces an encompassing time-varying parameter model to analyze the changing degree of U.S. inflation expectations anchoring. We confirm that inflation expectations have been partially de-anchored during the financial crisis. Yet, our results suggest that inflation expectations have been successfully reanchored ever since.

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

“…Perspective Mehrotra and Yetman (2014), Strohsal and Winkelmann (2015) and Strohsal et al (2016) investigate the anchoring of inflation expectations from a more dynamic perspective. This literature shares the notion that long-term inflation expectations, pushed away from the inflation target by a shock, are still anchored as long as they eventually return to the inflation target.…”

The anchoring of inflation expectations in time and frequency domains

“…Even so, inflation expectations remain well-anchored for the crisis period. Strohsal et al (2016) introduce an encompassing time-varying parameter model to analyse the relationships among short-and long-term inflation expectations and lagged inflation in the U.S. They document that long-term inflation expectations respond to short-term expectations and not to lagged inflation.…”

“…So far, approaches in the empirical literature accounting for time-varying anchoring are based on regime-dependent constant parameter models (Autrup & Grothe, 2014;Galati et al, 2011), multiple endogenous break point tests (Nautz & Strohsal, 2015) or time-varying parameter methods (Strohsal et al, 2016). The difference across time intervals, or specifically, frequencies is rarely considered.…”

“…Although there is clear evidence supporting a timevarying anchoring of inflation expectations, most previous empirical studies assume an intrinsically constant degree of anchoring, e.g., Beechey, Johannsen and Levin (2011). A time-varying anchoring of inflation expectations is estimated in certain studies through regime-dependent constant parameter models (Nautz, Pagenhardt & Strohsal, 2017) and time-varying parameter models (Demertzis, Marcellino & Viegi, 2012;Strohsal, Melnick & Nautz, 2016). Nevertheless, the possibility that the linkage between short-and long-term inflation expectations changes across frequency bands or, loosely speaking, 'time intervals' is rarely discussed.…”

Central bank transparency and the volatility of exchange rates

“…Thus, the effect critically depends on whether central bank transparency is able to anchor inflation expectations successfully. This, however, is only the case if changes in the current inflation rate have only a marginal or no impact at all on inflation expectations (see, e.g., Van der Cruijsen and Strohsal et al, 2016).…”