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The Formation of Inflation Expectations under Changing Inflation Regimes

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Author Info

  • Dahl Christian M.

    (Purdue University)

  • Hansen Niels L.

    (Danmarks Nationalbank)

Abstract

The present article offers a careful description of empirical identification of possible multiple changes in regime. We apply recently developed tools designed to select among regime-switching models among a broad class of linear and nonlinear regression models and provide a discussion of the impact on the formation of inflation expectations in the presence of multiple and recurrent changes in inflation regimes. Our empirical findings give a plausible explanation as to why the rational-expectations hypothesis based on direct measures of inflation expectations from survey series is typically rejected because of large systematic differences between actual and expected inflation rates. In particular, our results indicate that in the case of changing and not perfectly observed inflation regimes, inference about rationality and unbiasedness based on a comparison of ex ante forecasts from survey series and actual inflation rate based on ex post realizations will be ambiguous because of the presence of an ex post bias. The empirical findings are based on Danish inflation rates covering 1957-1998. We show that it is not possible to reject the hypothesis of multiple inflationary regimes and that the actual inflation rate can be represented by a two-state Markov regime-switching model. It turns out that the real-time forecasts produced from this model exhibit a large degree of similarity when compared to the direct measures of inflation expectations. The result illustrates the important impact of switching regimes on the formation of actual and expected inflation and hence of ex post bias as a main contributor to the difference between actual and expected inflation observed directly from survey series.

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Bibliographic Info

Article provided by De Gruyter in its journal Studies in Nonlinear Dynamics & Econometrics.

Volume (Year): 4 (2001)
Issue (Month): 4 (January)
Pages: 1-31

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Handle: RePEc:bpj:sndecm:v:4:y:2001:i:4:n:2

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Web page: http://www.degruyter.com

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Cited by:
  1. Juan Ayuso & Graciela L. Kaminsky & David López-Salido, 2003. "Inflation regimes and stabilisation policies: Spain 1962-2001," Investigaciones Economicas, Fundación SEPI, vol. 27(3), pages 615-631, September.
  2. Ishak-Kasim, Syurkani & Ahmed, Abdullahi D., 2009. "Inflation expectations formation and financial stability in Indonesia," MPRA Paper 27763, University Library of Munich, Germany.
  3. Angelo M. Fasolo & Marcelo Savino Portugal, 2003. "Imperfect Rationality and Inflationary Inertia: a New Estimation of the Phillips Curve for Brazil," Anais do XXXI Encontro Nacional de Economia [Proceedings of the 31th Brazilian Economics Meeting] b34, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
  4. Jeannine Bailliu & Eiji Fujii, 2004. "Exchange Rate Pass-Through and the Inflation Environment in Industrialized Countries: An Empirical Investigation," Working Papers 04-21, Bank of Canada.
  5. Georgios Chortareas & David Stasavage & Gabriel Sterne, 2003. "Does monetary policy transparency reduce disinflation costs?," Manchester School, University of Manchester, vol. 71(5), pages 521-540, 09.
  6. Matti Viren, 2006. "Inflation Expectations and Regime Shifts," Discussion Papers 5, Aboa Centre for Economics.

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