Decomposing the declining volatility of long-term inflation expectations

Todd Clark and Troy Davig

No RWP 09-05, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: The level and volatility of survey-based measures of long-term inflation expectations have come down dramatically over the past several decades. To capture these changes in inflation dynamics, we embed both short- and long-term expectations into a medium-scale VAR with stochastic volatility. The model documents a marked decline in the volatility of expectations, but also reveals a shift in the factors driving their movement. Throughout the 1980s and early 1990s, the majority of the variance in long-term expectations were driven by 'own' shocks. Beginning in the mid-1990s, however, the factors explaining the variance of long-term expectations began shifting amidst an overall decline in volatility. At the end of the sample in 2008, innovations to measures of inflation and output account for the majority of the remaining low-level of volatility in long-term expectations. We document a shift in monetary policy towards more systematic behavior that precedes the shift in the factors driving long-term expectations.

Date: 2009
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Journal Article: Decomposing the declining volatility of long-term inflation expectations (2011)
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