Decaying Expectations: What Inflation Forecasts Tell Us About the Anchoring of Inflation Expectations

36 Pages Posted: 1 Oct 2014

See all articles by Aaron N. Mehrotra

Aaron N. Mehrotra

Bank for International Settlements (BIS)

James Yetman

Bank for International Settlements (BIS)

Date Written: September 2014

Abstract

Well anchored inflation expectations are considered to be a reflection of credible monetary policy. In the past, anchoring has been assessed using either long-run inflation surveys or break-even inflation rates on financial assets with long maturities. But neither of these is ideal. Here we propose an alternative measure of inflation anchoring that makes full use of readily available, multiple-horizon, fixedevent forecasts. We show that a model where forecasts are assumed to diverge away from a long-run anchor towards actual inflation as the forecast horizon shortens fits the data well. It also provides simple estimates of the degree to which inflation expectations are anchored. Based on our estimation results we argue that inflation expectations have become more tightly anchored over time in both inflation targeting economies and in those following other regimes. However, inflation targeting regimes have seen a greater change along three dimensions: the level of the anchor has fallen further; the tightness of anchoring has increased more; and the relationship between the anchor and actual inflation outcomes has weakened to a greater degree.

Keywords: Inflation expectations, decay function, inflation targeting

JEL Classification: E31, E58

Suggested Citation

Mehrotra, Aaron N. and Yetman, James, Decaying Expectations: What Inflation Forecasts Tell Us About the Anchoring of Inflation Expectations (September 2014). BIS Working Paper No. 464, Available at SSRN: https://ssrn.com/abstract=2501661

Aaron N. Mehrotra (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

James Yetman

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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