Policy and macro signals as inputs to inflation expectation formation

Paul Hubert () and Becky Maule ()
Additional contact information
Paul Hubert: OFCE — Sciences Po.
Becky Maule: Bank of England, Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH

No 581, Bank of England working papers from Bank of England

Abstract: How do private agents interpret central bank actions and communication? To what extent do the effects of monetary shocks depend on the information disclosed by the central bank? This paper investigates the effect of monetary shocks and shocks to the Bank of England’s inflation and output projections on the term structure of UK private inflation expectations, to shed light on private agents’ interpretation of central bank signals about policy and the macroeconomic outlook. We proceed in three steps. First, we correct our dependent variables — market-based inflation expectation measures — for potential risk, liquidity and inflation risk premia. Second, we extract exogenous shocks following Romer and Romer (2004)’s identification approach. Third, we estimate the linear and interacted effects of these shocks in an empirical framework derived from the information frictions literature. We find that private inflation expectations respond negatively to contractionary monetary policy shocks, consistent with the usual transmission mechanism. In contrast, we find that inflation expectations respond positively to positive central bank inflation or output projection shocks, suggesting private agents put more weight on the signal that they convey about future economic developments than about the policy outlook. However, when shocks to central bank inflation projections are interacted with shocks to output projections of the same sign, they have no effect on inflation expectations, suggesting that private agents understand the functioning of the central bank reaction function and put more weight on the policy signal when there is no trade-off. We also find that the effects of contractionary monetary shocks are amplified when they are accompanied by positive shocks to central bank inflation projections. The co-ordination of policy decisions and macroeconomic projections thus appears important for managing inflation expectations.

Keywords: Monetary policy; information processing; signal extraction; market-based inflation expectations; central bank projections; real-time forecasts (search for similar items in EconPapers)
JEL-codes: E52 E58 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2016-01-22
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (25)

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Related works:
Working Paper: Policy and Macro Signals as Inputs to Inflation Expectation Formation (2016)
Working Paper: Policy and Macro Signals as Inputs to Inflation Expectation Formation (2016)
Working Paper: Policy and Macro Signals as Inputs to Inflation Expectation Formation (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0581

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