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Shocks, the Crisis and Uncertainty about Future Inflation: Theory and Evidence for the Euro Area

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Abstract

This study is motivated by the recent increase in volatility of both inflation and inflation expectations, triggered initially by the surge in commodity prices and more recently by the global economic crisis. While inflation uncertainty rose only moderately in response to the commodity and energy price shock in 2007, the financial and economic crisis triggered a dramatic increase across all types of agents, which was also reflected in historically large forecast errors. During the final months of 2009, both inflation expectations and uncertainty returned to more moderate levels. Uncertainty about future inflation may pose a problem both for monetary policy and for economic efficiency at large. Our study shows that various strands of economic theory offer quite diverse explanations for the mechanisms behind the formation of inflation expectations and the associated uncertainty. Our econometric estimates suggest that behavioral heuristics and information constraints or bounded rationality may indeed influence agents’ uncertainty about future inflation. For instance, both consumers and professional forecasters seem to invest more effort in forming expectations about future inflation if and when inflation developments become more salient. However, in the case of consumers faced with very large inflation shocks, this effect seems to be dampened by other behaviors. In contrast to consumers, professional forecasters’ uncertainty about future inflation reacts to news about the business cycle and monetary policy, which points to their use of a richer data set and more sophisticated models in forming inflation expectations.

Suggested Citation

  • Ernest Gnan & Johannes Langthaler & Maria Teresa Valderrama, 2010. "Shocks, the Crisis and Uncertainty about Future Inflation: Theory and Evidence for the Euro Area," Monetary Policy & the Economy, Oesterreichische Nationalbank (Austrian Central Bank), issue 1, pages 26-52.
  • Handle: RePEc:onb:oenbmp:y:2010:i:1:b:2
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    File URL: https://www.oenb.at/dam/jcr:968c059a-5463-43cb-a375-82c523207d91/mop_2010_q1_analyses_02_tcm16-190387.pdf
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    Cited by:

    1. Gary Koop & Luca Onorante, 2011. "Estimating Phillips Curves in Turbulent Times using the ECBs Survey of Professional Forecasters," Working Papers 1109, University of Strathclyde Business School, Department of Economics.

    More about this item

    Keywords

    inflation expectations; uncertainty; behavioral economics; heterogeneous agents;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General

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