Anchoring Firms' Inflation Expectations in Ukraine: Assessing Shock and Level Anchoring with a VAR Approach

This paper investigates the degree of anchoring of firms' inflation expectations in Ukraine over 2006-2025. Using a VAR model, we decompose inflation anchoring into two components: shock anchoring, which captures the sensitivity of inflation expectations to temporary shocks to inflation and expectations, and level anchoring, which reflects the perceived long-term inflation target. We extend the model to a time-varying framework with stochastic volatility to assess the stability of the estimated coefficients and track the evolution of anchoring over time. Our findings reveal that while firms' inflation expectations are moderately responsive to temporary shocks, the long-term perceived inflation anchor remains substantially higher than the central bank's target. Time-varying analysis shows that shock anchoring has remained relatively stable throughout the estimation period. However, the long-term inflation anchor experienced a considerable decline following the adoption of inflation targeting and disinflation, with a further increase triggered by the COVID-19 pandemic and russia's full-scale invasion of Ukraine. These dynamics highlight the challenges facing monetary policy in maintaining inflation expectations and the growing risk of de-anchoring if the gap between the perceived long-term anchor and the central bank's target continues to widen.