Inflation Levels and (In)Attention
Inflation expectations are key determinants of economic activity and are central to the current policy debate about whether inflation expectations will remain anchored in the face of recent pandemic-related increases in inflation. This paper explores evidence of inattention by constructing two different measures of consumers’ inattention and documents greater inattention when inflation is low. This suggests that there is indeed a risk of an acceleration in the increases in inflation expectations if actual inflation remains high.
Constrained Discretion and Central Bank Transparency
We develop and estimate a general equilibrium model to quantitatively assess the effects and welfare implications of central bank transparency. Monetary policy can deviate from active inflation stabilization and agents conduct Bayesian learning about the nature of these deviations. Under constrained discretion, only short deviations occur, agents? uncertainty about the macroeconomy remains contained, and welfare is high. However, if a deviation persists, uncertainty accelerates and welfare declines. Announcing the future policy course raises uncertainty in the short run by revealing that ...
What to expect from the lower bound on interest rates: evidence from derivatives prices
This paper analyzes the effects of the lower bound for interest rates on the distributions of inflation and interest rates. We study a stylized New Keynesian model where the policy instrument is subject to a lower bound to motivate the empirical analysis. Two equilibria emerge: In the “target equilibrium,” policy is unconstrained most or all of the time, whereas in the “liquidity trap equilibrium,” policy is mostly or always constrained. We use options data on future interest rates and inflation to study whether the decrease in the natural real rate of interest leads to forecast ...
Inflation Expectations and the News
This paper provides new evidence on the importance of inflation expectations for variation in nominal interest rates, based on both market-based and survey-based measures of inflation expectations. Using the information in TIPS breakeven rates and inflation swap rates, I document that movements in inflation compensation are important for explaining variation in long-term nominal interest rates, both unconditionally as well as conditionally on macroeconomic data surprises. Daily changes in inflation compensation and changes in long-term nominal rates generally display a close statistical ...
The effect of question wording on reported expectations and perceptions of inflation
Public expectations and perceptions of inflation may affect economic decisions, and have subsequent effects on actual inflation. The Michigan Survey of Consumers uses questions about "prices in general" to measure expected and perceived inflation. Median responses track official measure of inflation, showing some tendency toward overestimation and considerable disagreement between respondents. Possibly, responses reflect how much respondents thought of salient personal experiences with specific prices when being asked about "prices in general." Here, we randomly assigned respondents to ...
Fitting observed inflation expectations
This paper provides evidence on the extent to which inflation expectations generated by a standard Christiano et al. (2005)/Smets and Wouters (2003)?type DSGE model are in line with what is observed in the data. We consider three variants of this model that differ in terms of the behavior of, and the public?s information on, the central banks? inflation target, allegedly a key determinant of inflation expectations. We find that: 1) time-variation in the inflation target is needed to capture the evolution of expectations during the post-Volcker period; 2) the variant where agents have ...
Creating a History of U.S. Inflation Expectations
Central bankers closely monitor inflation expectations because they?re an important determinant of actual inflation. Treasury inflation-protected securities (TIPS) are commonly used to measure bond market inflation expectations. Unfortunately, they were only introduced in 1997, so historical data are limited. We propose a solution to this problem by using the relationship between TIPS yields and other data with a longer history to construct synthetic TIPS rates going back to 1971.
Inflation Expectations in Times of COVID-19
As an important driver of the inflation process, inflation expectations must be monitored closely by policymakers to ensure they remain consistent with long-term monetary policy objectives. In particular, if inflation expectations start drifting away from the central bank’s objective, they could become permanently “un-anchored” in the long run. Because the COVID-19 pandemic is a crisis unlike any other, its impact on short- and medium-term inflation has been challenging to predict. In this post, we summarize the results of our forthcoming paper that makes use of the Survey of Consumer ...
Average Inflation Targeting and Household Expectations
Using a daily survey of U.S. households, we study how the Federal Reserve’s announcement of its new strategy of average inflation targeting affected households’ expectations. Starting with the day of the announcement, there is a very small uptick in the minority of households reporting that they had heard news about monetary policy relative to prior to the announcement, but this effect fades within a few days. Those hearing news about the announcement do not seem to have understood the announcement: they are no more likely to correctly identify the Fed’s new strategy than others, nor ...
Tying down the anchor: monetary policy rules and the lower bound on interest rates
This paper uses a standard New Keynesian model to analyze the effects and implementation of various monetary policy frameworks in the presence of a low natural rate of interest and a lower bound on interest rates. Under a standard inflation-targeting approach, inflation expectations will be anchored at a level below the inflation target, which in turn exacerbates the deleterious effects of the lower bound on the economy. Two key themes emerge from our analysis. First, the central bank can eliminate this problem of a downward bias in inflation expectations by following an average-inflation ...