Researchers at Bank of International Settlements (BIS) have conducted a survey on how inflation expectations are influenced by financial turmoil. It is the first survey of its kind, and provides new insight on how these complex mechanisms works. The findings are also interesting.
“The turmoil in euro area bond markets triggered by the Greek fiscal crisis influenced short- and medium-term inflation
expectations but had only a very small impact on long-term expectations.”
Gabriele Galati, Peter Heemeijer and Richhild Moessner
Both the academic literature and policy discussions have highlighted the crucial importance of inflation expectations for the inflation process and hence central banks’ ability to achieve price stability. At the same time, evidence on the process through which agents form expectations is hard to obtain.
“The main novelty is that we provide empirical evidence on inflation expectations based on a survey that is both “accurate” and frequent, and in which we can assess the role of common information sets,” the three researchers writes in their report.
The study was conducted between July 2009 and July 2010, which has the additional advantage of capturing information on inflation expectations formation at a time of great financial and economic turmoil.
129 persons participated in the survey.
They were divided into three groups, with roughly equal weights in the experiment: central bankers (consisting of economists and research assistants from the Dutch Central Bank), academics and students.
Here are the main findings:
- “First, our evidence is consistent with long-term expectations having remained well anchored to the ECB’s definition of price stability, which acted as a focal point for long-term expectations.”
- “Second, the turmoil in euro area bond markets triggered by the Greek fiscal crisis influenced short- and medium-term inflation expectations but had only a very small impact on long-term expectations. By contrast, long-term expectations did not react to developments of the euro area wide fiscal burden.”
- “Third, participants changed their expectations fairly frequently. The longer the horizon, the less frequent but larger these changes were.”
- “Fourth, expectations exhibit a large degree of time variant non-normality.”
- “Fifth, inflation expectations appear fairly homogenous across groups of agents at the shorter horizon but less so at the medium- and long-term horizons. Moreover, we find that expectations of the central bank’s staff are the least volatile, and that they Granger cause those of academics and students.”
Perhaps not that surprising, but the survey documents that the experts view on future inflation have become increasingly different during the crisis. Specially when it comes to short, and medium term expectations.
“Three results stand out. First, we find that disagreement within our survey is smaller at the long-term horizon than at the short and medium horizons. Moreover, disagreement – as measured by the interquartile range – at the 10-year horizon was remarkably stable. One interpretation is that long-term expectations are driven by focal points – such as the ECB’s definition of price stability – while people form their short- and medium-term expectations based more on time-varying information. Second, we find that disagreement decreased in the course of 2010 at the short horizon, especially on the robust measure of interquartile range, probably because available information on actual information in 2010 was factored in. Third, disagreement at the two-year horizon exceeded that at the one-year horizon,” the BIS researchers writes.