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An empirical assessment of the relationships among inflation and short- and long-term expectations

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  • Todd E. Clark
  • Troy Davig

Abstract

This paper uses a detailed literature review and an empirical analysis of three models to assess the links among inflation and survey measures of long- and short-term expectations. In the first approach, we jointly estimate a model of inflation, survey expectations and monetary policy, where each is a function of a common time-varying inflation trend. In the estimates, long-term expectations track closely the unobserved trend that is an important factor in inflation dynamics, implying that changes in long-run expectations can lead to persistent movements in inflation. In the second approach, we estimate a time-varying parameter VAR with stochastic volatility. This model relaxes the cross-equation and constant parameter restrictions from the first model. Impulse response analysis shows a relatively stable relationship between inflation and survey measures of inflation, although with some modest changes consistent with improved anchoring of long-term expectations. Finally, we rely on a conventional VAR framework incorporating several macroeconomic variables, including both short- and long-term measures of expected inflation. In these estimates, shocks to either measure of expectations lead to a rise in the other measure and some limited pass-through to inflation. Shocks to inflation cause both short- and long-term expectations to rise. Other factors such as monetary policy, economic activity, and food price inflation also affect expectations and inflation.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 08-05.

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Date of creation: 2008
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Handle: RePEc:fip:fedkrw:rwp08-05

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Cited by:
  1. Koop, Gary & Onorante, Luca, 2011. "Estimating Phillips Curves in Turbulent Times using the ECB’s Survey of Professional Forecasters," SIRE Discussion Papers 2011-19, Scottish Institute for Research in Economics (SIRE).
  2. Joshua C. C. Chan & Gary Koop & Simon M. Potter, 2013. "A New Model of Trend Inflation," Journal of Business & Economic Statistics, American Statistical Association, vol. 31(1), pages 94-106, January.
  3. Gabriele Galati & Peter Heemeijer & Richhild Moessner, 2011. "How do inflation expectations form? New insights from a high-frequency survey," BIS Working Papers 349, Bank for International Settlements.

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