Communication, information and inflation expectations

This paper examines how the formation of inflation expectations and the magnitude of prediction errors vary among price setters based on the central bank’s communication and their level of information. We utilize dynamic panel data models to determine the importance of firms’ information about the prevailing inflation rate and the official inflation target. Our analysis reveals that the communicated tone of monetary policy amplifies the existing bias of the monetary policy instrument when these two are consistent. However, the credibility of the central bank’s communication diminishes when the stated tone and the implemented policy instruments diverge. By analyzing the interplay between information about inflation and the tone of the central bank’s monetary policy statements, we conclude that agents with partial information form their expectations distinctly. Notably, for these partially informed agents, the credibility of communication is not necessarily undermined by a mismatch between the stated tone and policy instruments. Furthermore, agents with complete information exhibit lower prediction errors.