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Policy and macro signals as inputs to inflation expectation formation

Author

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  • Hubert, Paul

    (OFCE — Sciences Po.)

  • Maule, Becky

    (Bank of England)

Abstract

How do private agents interpret central bank actions and communication? To what extent do the effects of monetary shocks depend on the information disclosed by the central bank? This paper investigates the effect of monetary shocks and shocks to the Bank of England’s inflation and output projections on the term structure of UK private inflation expectations, to shed light on private agents’ interpretation of central bank signals about policy and the macroeconomic outlook. We proceed in three steps. First, we correct our dependent variables — market-based inflation expectation measures — for potential risk, liquidity and inflation risk premia. Second, we extract exogenous shocks following Romer and Romer (2004)’s identification approach. Third, we estimate the linear and interacted effects of these shocks in an empirical framework derived from the information frictions literature. We find that private inflation expectations respond negatively to contractionary monetary policy shocks, consistent with the usual transmission mechanism. In contrast, we find that inflation expectations respond positively to positive central bank inflation or output projection shocks, suggesting private agents put more weight on the signal that they convey about future economic developments than about the policy outlook. However, when shocks to central bank inflation projections are interacted with shocks to output projections of the same sign, they have no effect on inflation expectations, suggesting that private agents understand the functioning of the central bank reaction function and put more weight on the policy signal when there is no trade-off. We also find that the effects of contractionary monetary shocks are amplified when they are accompanied by positive shocks to central bank inflation projections. The co-ordination of policy decisions and macroeconomic projections thus appears important for managing inflation expectations.

Suggested Citation

  • Hubert, Paul & Maule, Becky, 2016. "Policy and macro signals as inputs to inflation expectation formation," Bank of England working papers 581, Bank of England.
  • Handle: RePEc:boe:boeewp:0581
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    Cited by:

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    3. Paul Hubert & Fabien Labondance, 2016. "Central Bank Sentiment and Policy Expectations," SciencePo Working papers Main hal-03459227, HAL.
    4. Paul Hubert & Fabien Labondance, 2016. "The Effect of ECB Forward Guidance on Policy Expectations," Working Papers hal-01394821, HAL.
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    7. Silvia Miranda-Agrippino & Giovanni Ricco, 2021. "The Transmission of Monetary Policy Shocks," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(3), pages 74-107, July.
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    9. repec:hal:spmain:info:hdl:2441/2t6uivimtr9438i2qqu6kgfded is not listed on IDEAS
    10. repec:hal:spmain:info:hdl:2441/4evh7bju58uep3gd1frcn5nr9 is not listed on IDEAS
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    12. Paweł Baranowski & Wirginia Doryń & Tomasz Łyziak & Ewa Stanisławska, 2020. "Words and deeds in managing expectations: empirical evidence on an inflation targeting economy," NBP Working Papers 326, Narodowy Bank Polski.
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    More about this item

    Keywords

    Monetary policy; information processing; signal extraction; market-based inflation expectations; central bank projections; real-time forecasts;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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