Do words affect expectations? The effect of central banks communication on consumer inflation expectations

In this paper, we sought to investigate the effect of communication by central banks on consumer inflation expectations. To this end, we ran investigations into six European economies that, between 2010 and mid-2019, implemented inflation targeting: the Czech Republic, Hungary, Poland, Romania, Sweden, and the UK. Consumer inflation expectations were derived from qualitative surveys and quantified by probabilistic method. The communication tone of the central banks was derived from their minutes. We applied the textual method and latent Dirichlet allocation technique to derive minutes content that describes decision and underling economic conditions. For the sample collected, we estimated, controlling for past inflation and industrial production index, panel models. As some data proved to be fractionally integrated, we applied double filtering using the autoregressive fractionally integrated moving average method to account for autocorrelation followed by multilevel modelling. We estimated the model for two vectors of controls and four lexicons. The results suggest that the communication tone of a central bank affects consumer inflation expectations. However, the direction of relationship is conditional on dictionary.