The economics of the Phillips curve: Formation of inflation expectations versus incorporation of inflation expectations

This paper examines the theory of the Phillips curve, focusing on the distinction between “formation” of inflation expectations and “incorporation” of inflation expectations. Phillips curve theory has largely focused on the former. Explaining the Phillips curve by reference to expectation formation keeps Phillips curve theory in the policy orbit of natural rate thinking where there is no welfare justification for higher inflation even if there is a permanent inflation–unemployment trade-off. Explaining the Phillips curve by reference to incorporation of inflation expectations breaks that orbit and provides a welfare economics rationale for Keynesian activist policies that reduce unemployment at the cost of higher inflation.     

The properties of survey-based inflation expectations in Sweden

This article assesses the properties of survey-based inflation expectations in Sweden. The survey in question is conducted by Prospera once every quarter and consists of respondents from businesses and labour-market organisations. The article shows that inflation expectations measured in this survey tend to be biased and inefficient forecasts of future inflation. Moreover, evaluations of forecast accuracy show that these inflation expectations are worse predictors of inflation than those of a professional forecasting institution and also typically outperformed by a simple autoregressive model. Given that the true inflation expectations are captured by the survey, our results indicate that economic agents’ expectations formation process is suboptimal.     

The time-varying degree of inflation expectations anchoring

Well-anchored inflation expectations have become a key indicator for the credibility of a central bank’s inflation target. Since the outbreak of the financial crisis, the (de-)anchoring of long-term U.S. inflation expectations has been under debate. We propose a time-varying parameter (TVP) model in order to explore gradual changes in central bank credibility and the corresponding degree of inflation expectations anchoring. Our results confirm that inflation expectations have been partially de-anchored during the financial crisis. However, the TVP model reveals that inflation expectations have been successfully re-anchored ever since.     

The dynamics of persistence in US inflation

Using a recently developed time-series approach, we show that post-WWII US inflation became highly persistent during the ‘Great Inflation’ period, and then switched back to a low persistence process during 1984, and has remained stationary until the present day.     

Inflation targeting and inflation expectations in Mexico

In this article we analyse inflation expectations in Mexico. After a review of the theoretical and empirical literature, we apply unit root, normality and cointegration tests to the data provided by Banco de México (Banxico) in the Survey on the Expectations of the Private Sector Economics Specialists. Our results reject the null hypothesis of normality for inflation expectations over the period 2004:01–2011:12. The exchange rate has become one of the most relevant variables in the transmission mechanism of monetary policy in a small open economy. In this regard, we show the existence of a long-run relationship between nominal exchange rate and interest rate where inflation expectations matter for long-term dynamics.     

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.     

Dynamic asset allocation and consumption under inflation inequality: The impacts of inflation experiences and expectations

Differences in spending patterns and in price increases across goods and services lead to the unequal inflation experiences of households (called inflation inequality). These differences then cause disagreements in inflation expectations and eventually have a significant effect on households’ asset allocation and consumption decisions. The asset allocation model in this paper explains how inflation experiences affect household investment and consumption through corresponding inflation expectations, which are characterized by long-term expected inflation, the impact coefficient of the expected inflation and the correlation between expected inflation and the risky return. Using China's economic data, the empirical results show that significant differences in inflation expectation arise from income gap, regional inequality, different inflation measures and economic sector spending differences. Using the estimated coefficients, the calibration results have policy implications that households need more financing channels to resist inflation, especially in rural areas and in the raw material sector.     

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.     

A model of inflation and expectations in Latin America

This paper attempts to overcome certain shortcomings in the existing tests of various theories of inflation and cyclical income growth. It does so by appending a simple model of expectations formation to a simple macroeconomic simultaneous equation model of aggregate supply and demand. Some of the theoretical building blocs are reformulated so as to be more realistic for developing countries. Simultaneous equation estimation techniques are applied to a pooled sample of time series data for 16 Latin American countries. The authors provide empirical evidence supporting the revised hypotheses and offering new insights into the relationships among the actual and expected rates of inflation, the rate of income growth, and the growth rate of the money supply.     

Time-varying persistence in US inflation

The persistence property of inflation is an important issue not only for economists, but especially for central banks, given that the degree of inflation persistence determines the extent to which central banks can control inflation. Further, not only is it the level of inflation persistence that is important in economic analyses, but also the question of whether the persistence varies over time, for instance, across business cycle phases, is equally pertinent, since assuming constant persistence across states of the economy is sure to lead to misguided policy decisions. Against this backdrop, we extend the literature on long-memory models of inflation persistence for the US economy over the monthly period of 1920:1–2014:5, by developing an autoregressive fractionally integrated moving-average-generalized autoregressive conditional heteroskedastic model with a time-varying memory coefficient which varies across expansions and recessions. In sum, we find that inflation persistence does vary across recessions and expansions, with it being significantly higher in the former than in the latter. As an aside, we also show that persistence of inflation volatility is higher during expansions than in recessions. Understandably, our results have important policy implications.     

The expectations theory of the term structure: Evidence from inflation forecasts

This paper tests the joint hypothesis of rational expectations and the expectations theory of the term structure using the Livingston survey data on price inflation forecasts. For a variety of sample periods, the paper presents evidence that the data are consistent with the theory. Since inflation forecasts, unlike interest rates, are not linked to specific underlying financial assets, the relationship between longterm and short-term inflation forecasts should not embody risk premia. This paper's findings therefore lend support to the view that a time-varying risk premium is needed to explain the observed term structure of interest rates.     

Fitting survey expectations and uncertainty about trend inflation

Many studies document that the inflation rate is governed by persistent trend shifts and time-varying uncertainty about trend inflation. As both these quantities are unobserved, a forecaster has to learn about changes in trend inflation by a signal extraction procedure. I suggest that the forecaster uses a simple IMA(1, 1) model because it is well suited to forecast inflation and it provides an efficient way to solve the signal extraction problem. I test whether this model provides a good fit for expectations from the Survey of Professional Forecasters. The model appears to be well suited to model observed inflation expectations if we allow for stochastic volatility. When I estimate the implied learning rule, results are supportive for the trend learning hypothesis. Moreover, stochastic volatility seems to influence the way agents learn over time. It appears that survey participants systematically adapt their learning behavior when inflation uncertainty changes.     

A consistent model of the expectations augmented Phillips curve and inflation

The usual version of the expectations-augmented Phillips curve is shown to contain several inconsistencies. In particular, it does not take account of the dependence of labor demand and supply on the real wage, nor does it treat the goods and labor markets symmetrically. When the model is revised to meet these points, it is found that standard accelerationist results are largely unaffected. However, the important issue as to whether inflation accelerates depends not on wage but on price behavior. A unit coefficient on the expectations variable in the wage equation is seen to be irrelevant to this question.     

Disagreement in inflation expectations: empirical evidence for Colombia

The literature on expectation disagreements in emerging economies is scarce. This paper examines the disagreements in inflation expectations for the Colombian economy during the 2010–2017 period. We combine empirical tests with an analysis of a monthly survey of expectations of financial analysts in Colombia to obtain valuable evidence to formulate guidelines on the expectations modelling in developing economies. The findings indicate that disagreements present inertia and that inflation volatility increases disagreements. However, the central bank’s stance, as established through a press release, can reduce disagreement. Moreover, if central bank communication is clear and there is a credible inflation target, there tend to be fewer disagreements.     

How anchored are inflation expectations in EMU countries?

Anchored inflation expectations help stabilize inflation. Previous results indicate that monetary policy has been effective in breaking the link between actual and expected inflation at the euro area level. In this paper we examine whether this is also true at the national level. We define the ‘disconnect’ between inflation and inflation expectations and then proceed to examine the extent to which this disconnect exists for a number of euro area countries. Our findings suggest that for some countries, their own inflation experiences still affect national inflation expectations, and certainly more by comparison to how they affect the aggregate euro area level.     

Inflation persistence,inflation expectations,and monetary policy in China

This paper constructs a quarterly series of GDP deflator inflation for China from 1979 to 2009 and tests for a structural break with an unknown change point in the dynamic inflation process. Empirical results suggest a significant structural change in inflation persistence. Employing a counterfactual simulation method, we show that the structural change is primarily attributed to better conduct of monetary policy and the resultant better anchored inflation expectations. This finding implies that the quiescence of inflation in China over the past decade could well be followed by a return to a high inflation era in the absence of a determined effort by the monetary authorities in managing inflation expectations. Therefore, the use of a preemptive monetary policy to anchor inflationary expectations and to keep inflation moderate is warranted in China.     

Individual-rational and group-rational inflation expectations: Theory and cross-section evidence

A distinction is drawn between individual-rational and group-rational inflation expectations. Survey data for Israel show that individual inflation expectations are influenced by socioeconomic and psychological variables — specifically, interpersonal trust, age and income.