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1
INFLATION EXPECTATIONS – A POLICY TOOL?
Olivier Coibion (UT Austin and NBER)
Yuriy Gorodnichenko
(UC Berkeley and NBER)
Saten Kumar (Auckland University of Technology)
Mathieu Pedemonte
(UC Berkeley)
2
WHY INFLATION EXPECTATIONS?
Key variable for economic decisions: perceived real interest rate
𝑖 𝐸 𝜋
3
WHY INFLATION EXPECTATIONS?
Key variable for economic decisions: perceived real interest rate
𝑖 𝐸 𝜋
Conventional monetary policy:
• Anchor inflation expectations 𝐸 𝜋 • Increase/decrease nominal interest rate 𝑖
4
WHY INFLATION EXPECTATIONS?
Key variable for economic decisions: perceived real interest rate
𝑖 𝐸 𝜋
Conventional monetary policy:
• Anchor inflation expectations 𝐸 𝜋 • Increase/decrease nominal interest rate 𝑖
Unconventional monetary policy
• Manipulate inflation expectations 𝐸 𝜋 • Nominal interest rate is at the zero lower bound (ZLB)
5
WHY INFLATION EXPECTATIONS?
Key variable for economic decisions: perceived real interest rate
𝑖 𝐸 𝜋
Conventional monetary policy:
• Anchor inflation expectations 𝐸 𝜋 • Increase/decrease nominal interest rate 𝑖
Unconventional monetary policy
• Manipulate inflation expectations 𝐸 𝜋 • Nominal interest rate is at the zero lower bound (ZLB)
Mario Draghi (2015): “When inflation expectations go up with zero nominal rates, real rates go down. When real rates go down, investments and the economic activity improves. That’s the reasoning [of QE].”
6
STANDARD MECHANISMS Households consume more: when inflation expectations rise and nominal interest rates
are unchanged (ZLB), real interest rates are lower, so households should save less and spend more.
Firms invest more and hire more workers: when inflation expectations rise and nominal interest rates are unchanged (ZLB), real interest rates are lower so user cost of capital and labor are lower, inducing firms to raise their capital and employment.
Firms raise their prices: with sticky prices, inflation lowers firms’ relative price over time, so expectation of higher inflation induces them to raise prices more than they would otherwise.
Workers raise their wage demands: with sticky wages, inflation lowers the real wage over time, so expectations of higher inflation induce workers to raise wage demands, which should raise prices further.
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SOME PRACTICAL QUESTIONS Whose expectations should central banks use for policymaking?
8
SOME PRACTICAL QUESTIONS Whose expectations should central banks use for policymaking?
• Households and firms (and financial markets)
9
SOME PRACTICAL QUESTIONS Whose expectations should central banks use for policymaking?
• Households and firms (and financial markets)
What influences household/firm inflation expectations when inflation is low?
10
SOME PRACTICAL QUESTIONS Whose expectations should central banks use for policymaking?
• Households and firms (and financial markets)
What influences household/firm inflation expectations when inflation is low?
• Salient prices of frequently-purchased, homogenous goods
11
SOME PRACTICAL QUESTIONS Whose expectations should central banks use for policymaking?
• Households and firms (and financial markets)
What influences household/firm inflation expectations when inflation is low?
• Salient prices of frequently-purchased, homogenous goods
Can central banks manipulate inflation expectations?
12
SOME PRACTICAL QUESTIONS Whose expectations should central banks use for policymaking?
• Households and firms (and financial markets)
What influences household/firm inflation expectations when inflation is low?
• Salient prices of frequently-purchased, homogenous goods
Can central banks manipulate inflation expectations?
• Yes. Households and firms revise their beliefs in response to incoming information (but central banks often fail to reach households and firms)
13
SOME PRACTICAL QUESTIONS Whose expectations should central banks use for policymaking?
• Households and firms (and financial markets)
What influences household/firm inflation expectations when inflation is low?
• Salient prices of frequently-purchased, homogenous goods
Can central banks manipulate inflation expectations?
• Yes. Households and firms revise their beliefs in response to incoming information (but central banks often fail to reach households and firms)
Do economic agents react to changes in inflation expectations?
14
SOME PRACTICAL QUESTIONS Whose expectations should central banks use for policymaking?
• Households and firms (and financial markets)
What influences household/firm inflation expectations when inflation is low?
• Salient prices of frequently-purchased, homogenous goods
Can central banks manipulate inflation expectations?
• Yes. Households and firms revise their beliefs in response to incoming information (but central banks often fail to reach households and firms)
Do economic agents react to changes in inflation expectations?
• Yes. They update their consumption/employment/pricing/etc. (but mechanisms remain unclear)
15
SOME PRACTICAL QUESTIONS Whose expectations should central banks use for policymaking?
• Households and firms (and financial markets)
What influences household/firm inflation expectations when inflation is low?
• Salient prices of frequently-purchased, homogenous goods
Can central banks manipulate inflation expectations?
• Yes. Households and firms revise their beliefs in response to incoming information (but central banks often fail to reach households and firms)
Do economic agents react to changes in inflation expectations?
• Yes. They update their consumption/employment/pricing/etc. (but mechanisms remain unclear)
What are the challenges in using inflation expectations as a policy tool?
16
SOME PRACTICAL QUESTIONS Whose expectations should central banks use for policymaking?
• Households and firms (and financial markets)
What influences household/firm inflation expectations when inflation is low?
• Salient prices of frequently-purchased, homogenous goods
Can central banks manipulate inflation expectations?
• Yes. Households and firms revise their beliefs in response to incoming information (but central banks often fail to reach households and firms)
Do economic agents react to changes in inflation expectations?
• Yes. They update their consumption/employment/pricing/etc. (but mechanisms remain unclear)
What are the challenges in using inflation expectations as a policy tool? • Measurement of inflation expectations (especially firms) • Breaking through the veil of inattention
17
WHOSE INFLATION EXPECTATIONS?
01
23
45
67
89
1011
infla
tion
expe
ctat
ions
, one
-yea
r ahe
ad, %
per
yea
r
1980 1985 1990 1995 2000 2005 2010 2015
Asset Prices (Cleveland Fed)Professional forecasters (SPF)
18
WHOSE INFLATION EXPECTATIONS?
01
23
45
67
89
1011
infla
tion
expe
ctat
ions
, one
-yea
r ahe
ad, %
per
yea
r
1980 1985 1990 1995 2000 2005 2010 2015
Asset Prices (Cleveland Fed)Professional forecasters (SPF)Households (MSC)
19
WHOSE INFLATION EXPECTATIONS?
Expectations are not interchangeable across agents
01
23
45
67
89
1011
infla
tion
expe
ctat
ions
, one
-yea
r ahe
ad, %
per
yea
r
1980 1985 1990 1995 2000 2005 2010 2015
Asset Prices (Cleveland Fed)Professional forecasters (SPF)Households (MSC)Firms
20
WHAT FORCES INFLUENCE INFLATION EXPECTATIONS?
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WHAT FORCES INFLUENCE INFLATION EXPECTATIONS?
Predictors of inflation expectations
Perceptions/experience of inflation
22
WHAT FORCES INFLUENCE INFLATION EXPECTATIONS?
Predictors of inflation expectations
Perceptions/experience of inflation
Shopping
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WHAT FORCES INFLUENCE INFLATION EXPECTATIONS?
-2-1
01
2ga
solin
e pr
ice,
$ p
er g
allo
n (d
etre
nded
)
-4-2
02
4in
flatio
n ex
pect
atio
ns, %
per
yea
r (de
trend
ed)
1990 1995 2000 2005 2010 2015
Households (MSC)Gasoline price (right axis)
24
WHAT FORCES INFLUENCE INFLATION EXPECTATIONS?
Predictors of inflation expectations
Perceptions/experience of inflation
Shopping
Media
25
WHAT FORCES INFLUENCE INFLATION EXPECTATIONS?
Predictors of inflation expectations
Perceptions/experience of inflation
Shopping
Media
Policy
26
WHAT FORCES INFLUENCE INFLATION EXPECTATIONS?
Predictors of inflation expectations
Perceptions/experience of inflation (strong)
Shopping (strong)
Media (intermediate)
Policy (weak)
27
CAN WE MANIPULATE INFLATION EXPECTATIONS?
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CAN WE MANIPULATE INFLATION EXPECTATIONS?
Randomized controlled trials: provide subsets of firms or households with various bits of information and see how they update beliefs about inflation
Informational
treatment (inflation
target)
Elicit expectations (posteriors)
Elicit expectations
(priors)
29
CAN WE MANIPULATE INFLATION EXPECTATIONS?
Randomized controlled trials: provide subsets of firms or households with various bits of information and see how they update beliefs about inflation
Upshot:
• Households and firms appear to be Bayesian learners
Strength of priors Strength of signals
• Information effects are short-lived (less than 6 months)
Posterior beliefs
30
CAN WE MANIPULATE INFLATION EXPECTATIONS? Coibion, Gorodnichenko and Weber (2018)
Dep. var.: Revision of one-year-ahead inflation forecasts of U.S. consumers Treatment groups (coefficients are relative to control) Past inflation
-1.954*** (0.366)
Inflation target
-1.411*** (0.341)
FOMC inflation forecast
-2.004*** (0.384)
FOMC statement
-2.272*** (0.335)
USA Today coverage of FOMC statement
-0.950** (0.397)
31
CAN WE MANIPULATE INFLATION EXPECTATIONS? Coibion, Gorodnichenko and Weber (2018)
Dep. var.: Revision of one-year-ahead inflation forecasts of U.S. consumers Treatment groups (coefficients are relative to control) Past inflation
-1.954*** (0.366)
Inflation target
-1.411*** (0.341)
FOMC inflation forecast
-2.004*** (0.384)
FOMC statement
-2.272*** (0.335)
USA Today coverage of FOMC statement
-0.950** (0.397)
32
CAN WE MANIPULATE INFLATION EXPECTATIONS? Coibion, Gorodnichenko and Weber (2018)
Dep. var.: Revision of one-year-ahead inflation forecasts of U.S. consumers Treatment groups (coefficients are relative to control) Past inflation
-1.954*** (0.366)
Inflation target
-1.411*** (0.341)
FOMC inflation forecast
-2.004*** (0.384)
FOMC statement
-2.272*** (0.335)
USA Today coverage of FOMC statement
-0.950** (0.397)
33
HOW DO CONSUMERS AND FIRMS ACT ON THEIR INFLATION EXPECTATIONS?
Identification challenge: most of the time we see correlations
34
HOW DO CONSUMERS AND FIRMS ACT ON THEIR INFLATION EXPECTATIONS?
Identification challenge: most of the time we see correlations
Causal estimates are scarce
• Natural experiments (fiscal policy)
• Randomized controlled trials
35
HOW DO CONSUMERS AND FIRMS ACT ON THEIR INFLATION EXPECTATIONS?
Identification challenge: most of the time we see correlations
Causal estimates are scarce
• Natural experiments (fiscal policy)
• Randomized controlled trials
Informational treatment (inflation
target)
Elicit expectations (posteriors)
Elicit expectations (priors) and
plans
Measure outcomes
(relative to plans)
36
HOW DO CONSUMERS AND FIRMS ACT ON THEIR INFLATION EXPECTATIONS?
Consumers: higher expected inflation → higher consumer spending
37
HOW DO CONSUMERS AND FIRMS ACT ON THEIR INFLATION EXPECTATIONS?
Consumers: higher expected inflation → higher consumer spending
Firms: higher expected inflation → • New Zealand (2014-2016): higher employment and investment no effect on prices
• Italy (2012-2018) lower employment, lower investment plans higher prices
• France (1992-2016) higher prices
38
HOW DO CONSUMERS AND FIRMS ACT ON THEIR INFLATION EXPECTATIONS?
Consumers: higher expected inflation → higher consumer spending
Firms: higher expected inflation → • New Zealand (2014-2016): higher employment and investment no effect on prices
• Italy (2012-2018) lower employment, lower investment plans higher prices
• France (1992-2016) higher prices
Conclusions: • Households/firms react to changes in inflation expectations
39
HOW DO CONSUMERS AND FIRMS ACT ON THEIR INFLATION EXPECTATIONS?
Consumers: higher expected inflation → higher consumer spending
Firms: higher expected inflation → • New Zealand (2014-2016): higher employment and investment no effect on prices
• Italy (2012-2018) lower employment, lower investment plans higher prices
• France (1992-2016) higher prices
Conclusions: • Households/firms react to changes in inflation expectations • Manipulating inflation expectations can have a direct effect on prices
40
HOW DO CONSUMERS AND FIRMS ACT ON THEIR INFLATION EXPECTATIONS?
Consumers: higher expected inflation → higher consumer spending
Firms: higher expected inflation → • New Zealand (2014-2016): higher employment and investment no effect on prices
• Italy (2012-2018) lower employment, lower investment plans higher prices
• France (1992-2016) higher prices
Conclusions: • Households/firms react to changes in inflation expectations • Manipulating inflation expectations can have a direct effect on prices • … but need more research on mechanisms and general equilibrium effects
41
CHALLENGES IN USING INFLATION EXPECTATIONS AS A POLICY TOOL?
Measurement of inflation expectations (especially firms)
42
CHALLENGES IN USING INFLATION EXPECTATIONS AS A POLICY TOOL?
Measurement of inflation expectations (especially firms)
We have reasonably good measures of inflation expectations for households
We have poor measures of inflation expectations for firms
43
CHALLENGES IN USING INFLATION EXPECTATIONS AS A POLICY TOOL?
Measurement of inflation expectations (especially firms)
We have reasonably good measures of inflation expectations for households
We have poor measures of inflation expectations for firms
• Small, non-representative samples Example: Industry Trends Survey (Confederation of British Industry)
44
CHALLENGES IN USING INFLATION EXPECTATIONS AS A POLICY TOOL?
Measurement of inflation expectations (especially firms)
We have reasonably good measures of inflation expectations for households
We have poor measures of inflation expectations for firms
• Small, non-representative samples Example: Industry Trends Survey (Confederation of British Industry)
• Qualitative questions about inflation (“same”, “up”, “down”) Example: Business Survey (European Commission)
45
CHALLENGES IN USING INFLATION EXPECTATIONS AS A POLICY TOOL?
Measurement of inflation expectations (especially firms)
We have reasonably good measures of inflation expectations for households
We have poor measures of inflation expectations for firms
• Small, non-representative samples Example: Industry Trends Survey (Confederation of British Industry)
• Qualitative questions about inflation (“same”, “up”, “down”) Example: Business Survey (European Commission)
• Priming of responses (e.g., restrict possible responses) Example: Business Outlook Survey (Bank of Canada)
46
CHALLENGES IN USING INFLATION EXPECTATIONS AS A POLICY TOOL?
Measurement of inflation expectations (especially firms)
We have reasonably good measures of inflation expectations for households
We have poor measures of inflation expectations for firms
• Small, non-representative samples Example: Industry Trends Survey (Confederation of British Industry)
• Qualitative questions about inflation (“same”, “up”, “down”) Example: Business Survey (European Commission)
• Priming of responses (e.g., restrict possible responses) Example: Business Outlook Survey (Bank of Canada)
• Questions about firm-specific outcomes rather than aggregate outcomes Example: Business Inflation Expectations (BIE; FRB Atlanta)
47
CHALLENGES IN USING INFLATION EXPECTATIONS AS A POLICY TOOL?
Measurement of inflation expectations (especially firms)
We have reasonably good measures of inflation expectations for households
We have poor measures of inflation expectations for firms
• Small, non-representative samples
• Qualitative questions about inflation (“same”, “up”, “down”)
• Questions about firm-specific outcomes rather than aggregate outcomes
• Priming of responses (e.g., restrict possible responses)
Surveys of firms’ inflation expectations are expensive but they are most useful!
Good surveys: Ukraine and Uruguay
48
CHALLENGES IN USING INFLATION EXPECTATIONS AS A POLICY TOOL?
Measurement of inflation expectations (especially firms) Breaking through the veil of inattention
49
BREAKING THROUGH THE VEIL OF INATTENTION Perceived inflation target in the U.S.
0.2
.4.6
shar
e of
resp
onse
s
0 1 2 3 4 5 6 7 8 9 10+ DNK
FirmsHouseholds
50
BREAKING THROUGH THE VEIL OF INATTENTION
12
34
56
7
infla
tion
expe
ctat
ions
, one
-yea
r ahe
ad, %
Mic
higa
n Su
rvey
of C
onsu
mer
s
2011m1 2011m7 2012m1 2012m7 2013m1
January 2012: Fed annouces 2% IT
51
BREAKING THROUGH THE VEIL OF INATTENTION
Source: Deloitte Survey of Chief Financial Officers
-.50
.51
1.5
aver
age
scor
e
2015h2 2016h1 2016h2 2017h1 2017h2 2018h1
GermanyFranceItalySpainFinland
-.50
.51
1.5
aver
age
scor
e
2015h2 2016h1 2016h2 2017h1 2017h2 2018h1
NorwaySwedenPolandRussiaTurkey
Employment outlook; ECB announces QE tapering
52
BREAKING THROUGH THE VEIL OF INATTENTION Communication can work
• Public campaigns for other policies (healthcare, fiscal) work • Information treatment moves expectations
53
BREAKING THROUGH THE VEIL OF INATTENTION Communication can work
Simple messages are better • simple messages/facts are as effective as complex policy statements
Dep. var.: Revision of one-year-ahead inflation forecasts of U.S. consumers Treatment groups (coefficients are relative to control) FOMC inflation forecast
-2.004*** (0.384)
FOMC statement
-2.272*** (0.335)
54
BREAKING THROUGH THE VEIL OF INATTENTION Communication can work
Simple messages are better
Repeat the message • One-time announcements do not have long-lasting effects on expectations
of firms and households (information “depreciates” within months) • Need information campaigns
55
BREAKING THROUGH THE VEIL OF INATTENTION Communication can work
Simple messages are better
Repeat the message
Take the message directly to the target audience • Conventional media may be not good enough
Dep. var.: Revision of one-year-ahead inflation forecasts of U.S. consumers Treatment groups (coefficients are relative to control) FOMC statement
-2.272*** (0.335)
USA Today coverage of FOMC statement
-0.950** (0.397)
56
BREAKING THROUGH THE VEIL OF INATTENTION Communication can work
Simple messages are better
Repeat the message
Take the message directly to the target audience • Conventional media may be not good enough → Advertising, social media
Dep. var.: Revision of one-year-ahead inflation forecasts of U.S. consumers Treatment groups (coefficients are relative to control) FOMC statement
-2.272*** (0.335)
USA Today coverage of FOMC statement
-0.950** (0.397)
57
BREAKING THROUGH THE VEIL OF INATTENTION Communication can work
Simple messages are better
Repeat the message
Take the message directly to the target audience • Conventional media may be not good enough → Advertising, social media
• Potentially differentiate messages across audiences
58
BREAKING THROUGH THE VEIL OF INATTENTION Communication can work
Simple messages are better
Repeat the message
Take the message directly to the target audience • Conventional media may be not good enough → Advertising, social media
• Potentially differentiate messages across audiences
Currency bloc with booming “North” and lagging “South”
59
BREAKING THROUGH THE VEIL OF INATTENTION Communication can work
Simple messages are better
Repeat the message
Take the message directly to the target audience • Conventional media may be not good enough → Advertising, social media
• Potentially differentiate messages across audiences
Currency bloc with booming “North” and lagging “South”
One interest rate as a tool is not enough to address regional imbalances…
60
BREAKING THROUGH THE VEIL OF INATTENTION Communication can work
Simple messages are better
Repeat the message
Take the message directly to the target audience • Conventional media may be not good enough → Advertising, social media
• Potentially differentiate messages across audiences
Currency bloc with booming “North” and lagging “South”
One interest rate as a tool is not enough to address regional imbalances…
But one can have different messages for “North” to slow down and for “South” to accelerate.
61
BREAKING THROUGH THE VEIL OF INATTENTION Communication can work
Simple messages are better
Repeat the message
Take the message directly to the target audience • Conventional media may be not good enough → Advertising, social media
• Potentially differentiate messages across audiences
Target the message to the scenario • For example, if inflation is too low, emphasize the inflation target (rather
than actual inflation) to raise inflation expectations
62
CONCLUDING REMARKS Inflation expectations as a policy tool: large potential!
• Move consumption/employment/investment
• Directly influence prices
• Target specific areas, industries, or types of consumers
63
CONCLUDING REMARKS Inflation expectations as a policy tool: large potential!
• Move consumption/employment/investment
• Directly influence prices
• Target specific areas, industries, or types of consumers
Are we ready to use it?
64
CONCLUDING REMARKS Inflation expectations as a policy tool: large potential!
• Move consumption/employment/investment
• Directly influence prices
• Target specific areas, industries, or types of consumers
Are we ready to use it? Not yet…
• More research to study how inflation expectations translate into actions
• More high-quality surveys of firms’ inflation expectations
• New communication strategies to reach consumers and firms