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Inflation, deflation, and uncertainty: What drives euro-area option-implied inflation expectations, and are they still anchored in the sovereign debt crisis?

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  • Scharnagl, Michael
  • Stapf, Jelena

Abstract

We tackle two questions in this paper: In the sovereign debt crisis, what moves the euro-area inflation outlook, and has the firm anchoring of medium to long-term inflation expectations been affected? We try to answer these questions by looking at option-implied probability density functions of future inflation. Deriving densities from a new data set on options on the euro-area harmonised index of consumer prices (excluding tobacco) provides us with the full distribution of inflation expectations, including uncertainty and asymmetry of market participants' beliefs about the inflation outlook. The daily data set allows us to analyse the effects of monetary policy announcements and macro news in a time-varying event study framework despite the short sample period from 2009 to 2013. Due to renewed fears of deflation, we compare option-implied and statistical density functions to gain insight into deflation risk. Inflation expectations show a decreasing mean but growing uncertainty, especially since the intensification of the sovereign debt crisis in mid-2011. Around the same time, the influence of monetary policy announcements on inflation expectations across all horizons diminished. Tail events such as deflation, although still contained, have become more probable. The impact of macroeconomic news on inflation probabilities has overall decreased and shifted towards countries more affected by the crisis. This paper's results regarding the anchoring of inflation expectations are twofold: The mean and low sensitivity to actual news speak for anchored inflation expectations, whereas the growing uncertainty reveals market participants' concerns about possible extreme inflation or deflation outcomes in the future.

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  • Scharnagl, Michael & Stapf, Jelena, 2015. "Inflation, deflation, and uncertainty: What drives euro-area option-implied inflation expectations, and are they still anchored in the sovereign debt crisis?," Economic Modelling, Elsevier, vol. 48(C), pages 248-269.
  • Handle: RePEc:eee:ecmode:v:48:y:2015:i:c:p:248-269
    DOI: 10.1016/j.econmod.2014.11.025
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    3. Galati, Gabriele & Gorgi, Zion & Moessner, Richhild & Zhou, Chen, 2018. "Deflation risk in the euro area and central bank credibility," Economics Letters, Elsevier, vol. 167(C), pages 124-126.
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    8. Andrea Fracasso & Rocco Probo, 2017. "When did inflation expectations in the Euro area de-anchor?," Applied Economics Letters, Taylor & Francis Journals, vol. 24(20), pages 1481-1485, November.
    9. Gimeno, Ricardo & Ibáñez, Alfredo, 2018. "The eurozone (expected) inflation: An option's eyes view," Journal of International Money and Finance, Elsevier, vol. 86(C), pages 70-92.
    10. Mazumder, Sandeep, 2018. "Inflation in Europe after the Great Recession," Economic Modelling, Elsevier, vol. 71(C), pages 202-213.
    11. Xu, Kun & Cheng, Jian-hua & Xu, Wenli, 2016. "通胀及通胀预期冲击的动态特征分析 [Study on Dynamics of Inflation and Inflation Expectation Shocks in China]," MPRA Paper 71977, University Library of Munich, Germany.
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    13. Oinonen, Sami & Paloviita, Maritta & Viren, Matti, 2018. "Effects of monetary policy decisions on professional forecasters’ expectations and expectations uncertainty," Research Discussion Papers 24/2018, Bank of Finland.
    14. Aßhoff, Sina & Belke, Ansgar & Osowski, Thomas, 2020. "Unconventional monetary policy and inflation expectations in the euro area," Ruhr Economic Papers 837, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
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    16. Dash, Pradyumna & Rohit, Abhishek Kumar & Devaguptapu, Adviti, 2020. "Assessing the (de-)anchoring of households’ long-term inflation expectations in the US," Journal of Macroeconomics, Elsevier, vol. 63(C).

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