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Does Communicating a Numerical Inflation Target Anchor Inflation Expectations? Evidence & Bond Market Implications

Author

Listed:
  • Bundick, Brent

    () (Federal Reserve Bank of Kansas City)

  • Smith, Andrew Lee

    () (Federal Reserve Bank of Kansas City)

Abstract

High-frequency empirical evidence suggests that inflation expectations in the United States became better anchored after the Federal Reserve began communicating a numerical inflation target. Using an event-study approach, we find that forward measures of inflation compensation became unresponsive to news about current inflation after the adoption of an explicit inflation target. In contrast, we find that forward measures of nominal compensation in Japan continued to drift with news about current inflation, even after the Bank of Japan adopted a numerical inflation target. These empirical findings have implications for the term structure of interest rates in the United States. In a calibrated macro-finance model, we show that the apparent anchoring of inflation expectations implies lower term premiums in longer-term bond yields and decreases the slope of the yield curve.

Suggested Citation

  • Bundick, Brent & Smith, Andrew Lee, 2018. "Does Communicating a Numerical Inflation Target Anchor Inflation Expectations? Evidence & Bond Market Implications," Research Working Paper RWP 18-1, Federal Reserve Bank of Kansas City.
  • Handle: RePEc:fip:fedkrw:rwp18-01
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    File URL: https://doi.org/10.18651/RWP2018-01
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    Keywords

    Monetary Policy; Inflation; Structural Breaks; Term Structure of Interest Rates;

    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
    • 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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