CONSUMERS' INFLATION EXPECTATIONS AND MONETARY POLICY IN EUROPE

This article analyses the effects of monetary policy decisions on inflation expectations of European consumers. Using a novel approach, I convert qualitative survey responses of consumers in various European countries into a quantitative time series of inflation expectations. I investigate the effects of unanticipated movements in interest rates and inflation on inflation expectations across European countries. I inter alia seek to explore whether the reaction differs of consumers in countries with more credible central banks than those in less credible countries.     

Estimating inflation compensation for Turkey using yield curves

Inflation compensation derived from nominal and real bond yields contains market based, real time information regarding the inflation expectations and the pricing of inflation risks. In this study, we calculate inflation compensation for Turkey by using nominal and real yield curves. The findings of event study analysis on inflation compensation indicate that changes in the term structure of inflation compensation contain information regarding the credibility of monetary authority. Moreover, we find that, at daily frequency, liquidity conditions have no significant effect on inflation compensation and hence the effects of events such as monetary policy decisions and inflation surprises on inflation compensation can be attributed mainly to changes in inflation expectations and pricing of inflation uncertainty.     

Financial market imperfections and monetary policy strategy

In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank applying the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if interest rate pass-through is incomplete, the central bank can use a narrow monetary aggregate and the discount interest rate as independent and complementary policy instruments to reinforce the credibility of its announcements and the role of inflation target as a nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman's k-percent money growth rule, which can generate dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.     

Financial Deregulation and the Monetary Transmission Mechanism

Major changes to the Australian financial system in the 1980s may possibly have influenced the effects of monetary policy on economic activity. Using vector autoregressive econometric techniques we find that the deregulation of the financial system has made very little difference to the reduced form relationships among interest rates, employment growth, inflation and the growth rate of real credit. We find that interest rates are an important determinant of the business cycle, with credit being much less significant. We also find that monetary policy reacts to unexpected movements in real variables but does not react to surprises in the inflation rate.     

Term structure and forward guidance as instruments of monetary policy

This paper studies a simple monetary model with a Ricardian fiscal policy in which equilibria are indeterminate if monetary policy consists solely of a rule for fixing the short-term interest rate. We introduce explicitly into the model the agents’ expectations of inflation which create the indeterminacy and show that there are two types of policies—a term structure rule or a forward guidance rule for the short rate—which lead to determinacy. The first consists in fixing the interest rates on a family of bonds of different maturities as function of realized inflation; the second consists in fixing the short-term interest rate and the expected values of the short-term interest rate for a sequence of periods into the future as a function of realized inflation. If the monetary authority chooses an inflation process that satisfies conditions derived in the paper and applies one of these rules, it anchors agents’ expectations to this process, in the sense that it is the unique inflation process compatible with equilibrium when the interest rates or expected future values of the short rate are those specified by the term structure or forward guidance rule.     

The Impact of Monetary Surprises on Australian Financial Futures Markets: An Insight into Cash Rate Target Announcements

This paper investigates the impact of unanticipated Australian monetary policy changes on AUD/USD exchange rate futures, and 3‐year and 10‐year Australian Treasury bond futures, during the period from January 1997 to April 2010. Our study contributes to the literature by using both the 30‐day and the 90‐day bank accepted bill (BAB) rates to disentangle the unexpected surprise component of monetary policy changes from overall cash rate target changes in the Australian money market, and by concurrently modelling the effects of monetary surprises and other key macroeconomic announcements in Australia. The empirical results suggest that the 30‐day BAB rate is the best proxy for the expected monetary policy actions. We find that the effect of monetary surprises on the volatility of the 3‐ and 10‐year bond future instruments is significant and persistent. We have also documented a strong monetary policy effect on the mean returns of the exchange rate futures, indicating that unexpected monetary policy adjustments have a significant impact on the level of the exchange rate movements rather than on the volatility of the FX futures market.     

Assessing the effectiveness of monetary policy in Kenya: Evidence from a macroeconomic model

This paper examines the effectiveness of monetary policy in Kenya based on policy simulations from a structural macroeconometric model. The analysis is conducted using the policy rate, i.e. the central bank rate (CBR) and the cash reserve ratio (CRR) with respect to the interest rate and bank lending channels, respectively. The results indicate that whereas a change in the policy rate is effective in influencing short term rates, the long term lending rates respond marginally. Consequently, the transmission to the real economy and the overall impact on inflation is minimal. However, a change in CBR has a comparatively higher impact on inflation while a change in CRR has a relatively larger impact on aggregate demand. Enhancing the effectiveness of the CBR and strengthening of the interest rate channel have the potential of anchoring inflation expectations and boosting the effectiveness of monetary policy in Kenya.     

Labour markets, liquidity, and monetary policy regimes

Abstract.  We develop an equilibrium model of the monetary policy transmission mechanism that highlights information frictions in the market for money and search frictions in the labour market. The information friction increases the persistence in the response of interest rates following monetary policy regime shifts. This occurs because agents have incomplete information about the nature of the shifts and optimally update their inflation forecasts using an 'adaptive' expectations rule. The search friction transmits the interest rate movements to the labour market by affecting job creation activities; together, the two frictions imply that unemployment reacts very gradually to monetary policy shocks. JEL Classification: E4, E5     

Reactions of real yields and inflation expectations to forward guidance in the United States

We study the impact of forward policy rate guidance by the Federal Reserve’s Federal Open Market Committee (FOMC) used as an unconventional monetary policy tool at the zero lower bound of the policy rate on real and breakeven US Treasury yield curves. We find that explicit FOMC policy rate guidance announcements led to a significant reduction in real yields at horizons of 2 to 5 years ahead. By contrast, long-term breakeven inflation rates were little affected, suggesting that inflation expectations have remained well anchored, and that explicit FOMC policy rate guidance has not adversely affected central bank credibility.     

Inflationary expectations and monetary policy: evidence from Bangladesh

This article first estimates inflationary expectations using a Blanchard–Quah VAR model by decomposing the nominal interest rate into expected inflation and the ex ante real interest rate. Then I utilize this expected inflation along with other macroeconomic variables as inputs to the monetary policy function in a recursive VAR model to identify exogenous policy shocks. To calculate inflationary expectations, I assume that ex ante real interest rate shocks do not have a long-run effect on the nominal interest rate. This article finds that the public expects lower inflation for the future during periods of high inflation. Estimated results from the recursive VAR suggest that a contractionary policy shock increases the real interest rate, appreciates domestic currency, and lowers inflationary expectations and industrial output. However, I find a lagged policy response from Bangladesh Bank to higher inflationary expectations.     

Monetary policy reactions and the exchange rate: a regime-switching structural VAR for Canada

The objective of this study is to identify monetary policy reactions in a nonlinear, structural vector autoregression (VAR) framework, with regime-switching contemporaneous policy responses in a small open economy. The key finding is that monetary policy in Canada responds contemporaneously to disturbances in the real exchange rate, as well as the output gap and inflation. The Bank of Canada is found to have much larger responses to exchange rate fluctuations during volatile periods than more stable periods. However, the Bank is found statistically to have a relatively linear reaction function with symmetric responses to output and inflation shocks across interest rate regimes. The estimates for the contemporaneous responses to the output gap in both regimes are found to be virtually identical to the 0.5 weights in the original Taylor rule for the United States, while the responses to inflation surprises are slightly smaller. Overall, the Bank of Canada is found to have operated within the range of optimal responses suggested by small-scale structural models in the normative literature on monetary policy rules.     

Money non-neutrality in a Rational Belief Equilibrium with financial assets

Summary. In Rational Beliefs Equilibria money is generically non-neutral. Given the expectational perspective proposed by the Theory of Rational Belief Equilibrium, we show that one of the most important factors in the emergence of money non-neutrality is played by Endogenous Uncertainty. This, in contrast to the Rational Expectations results of money neutrality and policy ineffectiveness, leads to a scenario in which monetary policy has an impact on the real economy and price volatility. The heterogeneity of beliefs together with the distribution and intensity of agents' states of optimism/pessimism can amplify the real effect of monetary policy and/or generate endogenous fluctuations in the economy which are not explained by any exogenous shock. We claim that money non-neutrality is mostly an expectations driven phenomenon. Indeed, additional assumptions of asymmetry of information and/or unanticipated monetary policy are not needed to explain the real effect of monetary policy as it is customary in the New Classical Theory. Received: May 30, 2000; revised version: December 28, 2000     

The effect of FOMC statements on asset prices

Given their increased importance during recent years, FOMC (Federal Open Market Committee) statements can have a significant impact on asset prices. To capture the effect of FOMC statements on asset prices, an indicator variable is created that takes into account the information content of policy statements. Results show that both ‘interest rate surprises’ and ‘FOMC statements’ affect the mean and the volatility of asset prices. The volatility impact is tent-shaped, jumping within the policy announcement interval and declining before and after the release. FOMC statements have a much more pronounced impact on stock returns, intermediate and long-term yields, while short-term rates are largely driven by target rate decisions. We also find that the evolution of the language of the FOMC statements does matter to market participants and, in particular, the ‘forward-looking’ language adopted in mid-2003 has reduced market volatility associated with ‘interest rate surprises’ on announcement days.     

Observed expectations,news shocks,and the business cycle

This paper exploits information from the term structure of survey expectations to identify news shocks in a DSGE model with rational expectations.We estimate a structural business-cycle model with price and wage stickiness. We allow for both unanticipated and anticipated components (“news”) in each structural disturbance: neutral and investment-specific technology shocks, government spending shocks, risk premium, price and wage markup shocks, and monetary policy shocks.We show that the estimation of a standard DSGE model with realized data obfuscates the identification of news shocks and yields weakly or non-identified parameters pertaining to such shocks. The identification of news shocks greatly improves when we re-estimate the model using data on observed expectations regarding future output, consumption, investment, government spending, inflation, and interest rates - at horizons ranging from one-period to five-periods ahead.The news series thus obtained largely differ from their counterparts that are estimated using only data on realized variables. Moreover, the results suggest that the identified news shocks explain a sizable portion of aggregate fluctuations. News about investment-specific technology and risk premium shocks play the largest role, followed by news about labor supply (wage markup) and monetary policy.     

Peril of the Inflation Exit Condition

Recent empirical evidence on monetary policy in Japan suggests that exits from the zero‐interest‐rate policy triggered by policy shocks can be expansionary. This paper provides theoretical examples of such expansionary policy‐induced exits. The examples suggest that the exit condition (the Bank of Japan’s stated commitment of not exiting from the zero‐rate regime unless the inflation rate rises above a certain threshold) may have made it difficult for the economy to escape from the liquidity trap.     

The effectiveness of exchange-rate-based monetary policy: evidence from survey data

Singapore’s monetary policy is centred on the management of the exchange rate. We examine how macroeconomic forecasters perceive the effectiveness of this unconventional policy. We provide empirical evidence that forecasters’ expectations are consistent with a forward-looking exchange-rate-based Taylor-type policy rule. They expect monetary authorities to actively manage the currency against expected future changes in inflation and output.     

Inflation surprises and inflation expectations in the Euro area

In the second half of 2012, euro area inflation started declining and reached historical lows at the end of 2014. Market-based measures of inflation expectations also declined to unprecedented levels. During this disinflationary period, inflation releases have often surprised analysts on the downside. We provide evidence that inflation ‘surprises’ have significant effects on inflation expectations. The sensitivity of inflation expectations to the surprises, which has varied over time, disappeared after the introduction of the Asset Purchase Programme by the European Central Bank.     

Quantification and characteristics of household inflation expectations in Switzerland

Inflation expectations are a key variable in conducting monetary policy. However, these expectations are generally unobservable and only certain proxy variables exist, such as surveys on inflation expectations. This article offers guidance on the appropriate quantification of household inflation expectations in the Swiss Consumer Survey, where answers are qualitative in nature. We apply and evaluate different variants of the probability approach and the regression approach; we demonstrate that models that include answers on perceived inflation and allow for time-varying response thresholds yield the best results; and we show why the originally proposed approach of Fluri and Spörndli (1987) has resulted in heavily biased inflation expectations since the mid-1990s. Furthermore, we discuss some of the key features of Swiss household inflation expectations, i.e. the fact that there has been a shift in expectation formation since 2000 (expectations are better anchored and less adaptive, and there is lower disagreement of expectations). We suggest that this may be linked to the Swiss National Bank’s adjustment of its monetary policy framework around this time. In addition, we outline how expectation formation in Switzerland is in line with the sticky information model, where information disseminates slowly from professional forecasters to households.     

Fed speak on main street: Central bank communication and household expectations

Central banks emphasize the use of communication as a tool of monetary policy. As central banks increasingly recognize that low public informedness limits their ability to communicate with the general public, several have begun to explicitly tailor their communication strategies for a broader audience. Most research focuses on central bank communication with financial markets, but several recent strands of literature address aspects of communication with households. I survey the literature addressing the rationales and efficacy of central bank communication with households, supplementing this with new evidence from an assortment of consumer survey data. I draw from the literature on rational inattention, financial literacy, and political communication to suggest explanations for limited household receptiveness to central bank communications. Finally, I focus on one specific aim of central bank communication, which is to anchor inflation expectations. Previous literature finds that the announcement of an explicit inflation target helps anchor expectations among financial market participants. Using U.S. consumer survey data, I show that consumers’ expectations are imperfectly anchored and that the anchoring of more informed consumers’ expectations increased more than the anchoring of less informed consumers’ expectations following the Fed’s announcement of a 2% inflation target.