۱- Introduction

۲- Literature review

۳- Data and some stylized facts

۴- Econometric framework

۵- Empirical results

۶- Conclusions

References

Abstract

In this paper we investigate dynamics of inflation and short-run inflation expectations. We estimate a global vector autoregressive (GVAR) model using Bayesian techniques. We then explore the effects of three source of inflationary pressure that could drive up inflation expectations: domestic aggregate demand and supply shocks as well as a global increase in oil price inflation. Our results indicate that inflation expectations tend to increase as inflation accelerates. However, the effects of the demand and supply shocks are short-lived for most countries. When global oil price inflation accelerates, however, effects on inflation and expectations are often more pronounced and long-lasting. Hence, an assessment of the link between observed inflation and inflation expectations requires disentangling the underlying sources of inflationary pressure. We also examine whether the relationship between actual inflation and inflation expectations changed following the global financial crisis. The transmission between inflation and inflation expectations is found to be largely unaffected in response to domestic demand and supply shocks, while effects of an oil price shock on inflation expectations are smaller post-crisis.

Introduction

Inflation expectations are a pivotal variable in providing insights about likely future economic conditions. While the decades long debate about the degree to which monetary policy is forward looking has not abated (e.g., Friedman, 1968; Woodford, 2003a) there is little doubt that policy makers devote considerable attention to the economic outlook. Hence, the dynamics of the relationship between inflation and inflation expectations continues to pre-occupy the monetary authorities and central bankers. Even before the full impact of the global financial crisis (GFC) of 2008–۹ was felt in the US, and in many other parts of the globe, central bankers such as Bernanke (2007) highlighted the importance of inflation expectations since “… the state of inflation expectations greatly influences actual inflation …“. More recently, Yellen (2016) also underscores the crucial role played by expectations while bemoaning the fact that the profession must confront gaps in our knowledge about the relationship between observed inflation and the short-run inflation expectations that lies at the heart of many theoretical macroeconomic models. It is not difficult to come across speeches by central bankers who, on a regular basis, touch upon the subject of the formation and implications of inflation expectations.1 A main, but not sole, driver of inflation expectations is past inflation. At the risk of some over-simplification, inflation can be thought of as being driven by two sets of determinants, namely local or domestic factors versus international or global forces.2 The local determinants would include technical progress and changes in productivity, demographic factors, institutional considerations such as the adoption of inflation targeting and central bank independence and, since 2008, the adoption and maintenance of unconventional monetary policies in systemically important economies. More generally, however, economists tend to make the distinction between aggregate demand and supply sources of changes in inflation pressure. In what follows, we retain this distinction to allow for greater comparability with the extant literature as well as because it provides us with a vehicle to present new insights into the underlying drivers of inflation and ultimately about the likelihood that inflation expectations can be anchored.