Policy Performance and the Behavior of Inflation Expectations

Eda Gulsen () and Hakan Kara

International Journal of Central Banking, 2021, vol. 17, issue 70, 46

Abstract: This paper investigates the changing behavior of inflation expectations in response to the macroeconomic and policy environment. Using a panel of professional forecasters covering 13 years of inflation-targeting period in a major emerging economy, we present evidence on the behavioral shifts in the inflation expectations associated with evolving macroeconomic and policy performance. The rapidly changing nature of the policy setting and ample data variation in our data set constitute a suitable background to explore this question. We use a unique survey which includes matched policy rate and fixed-horizon inflation expectations at the individual level. Moreover, the paper employs a novel technique where direct feedback from the survey participants is used to determine the baseline empirical model governing expectations dynamics. Interpretation of the empirical findings jointly with the feedback from the survey respondents indicate that the anchoring power of inflation targets depend on the policy performance. The weights attached to inflation targets in forming expectations are strongly associated with the size of the inflation deviation from the targets. As the targets become less credible through time, the survey participants assign increasingly higher weight to past inflation and the relationship between exchange rates and inflation expectations becomes stronger. Overall, our results imply that expectations behavior might display significant and rapid shifts with the underlying economic and policy performance. Therefore, policymakers in advanced and emerging economies should not take the current stability of inflation expectations for granted.

JEL-codes: C51 C53 E31 E37 E58 (search for similar items in EconPapers)
Date: 2021
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