by Michael Ehrmann
Bank of Canada
Inflation targeting (IT) had originally been introduced as a device to bring inflation down and stabilize it at low levels. Given the current environment of persistently weak inflation in many advanced economies, IT central banks must now bring inflation up to target. This paper tests to what extent inflation expectations are anchored in such circumstances, by comparing across periods when inflation is around target, (persistently) high, or (persistently) weak. It finds that under persistently low inflation, inflation expectations are not as well anchored as when inflation is around target: inflation expectations are more dependent on lagged inflation; forecasters tend to disagree more; and inflation expectations get revised down in response to lower-than-expected inflation, but do not respond to higher-than-expected inflation. This suggests that central banks should expect inflation expectations to behave differently than was the case previously, when inflation was often remarkably close to target in many advanced economies.
JEL Codes: E52, E58, E31, C53.
Full article (PDF, 37 pages, 716 kb)
Discussion by Eric T. Swanson