Predicting inflation expectations: A habit-based explanation under hedging

Kwamie Dunbar and Johnson Owusu-Amoako

International Review of Financial Analysis, 2023, vol. 89, issue C

Abstract: One of the main challenges monetary policymakers face is predicting the trajectory of short-term inflation, especially considering the consistently flat Phillips curve observed in recent years. A promising approach to tackling this challenge involves modifying the hybrid New Keynesian Phillips curve (HNKPC) by incorporating a hedging factor. This factor accounts for the efforts risk-averse economic agents make to safeguard their spending decisions against uncertainties arising from inflation. Our study provides evidence that the hedging factor plays a crucial role and is a statistically significant predictor of the upcoming year's inflation rate. Specifically, a one-standard-deviation increase in the hedging factor predicts a positive rise in short-term inflation. Furthermore, we demonstrate that the hedging factor significantly determines the common component found in both well-known survey-based and model-based inflation expectation indicators.

Keywords: Futures market; Phillips curve; Inflation expectation; Hedging factor; Core inflation (search for similar items in EconPapers)
JEL-codes: E52 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:89:y:2023:i:c:s1057521923003320

DOI: 10.1016/j.irfa.2023.102816

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