Shocks to Inflation Expectations

Author: Barrett Philip and Adams Jonathan J

Volume/Issue: Volume 2022 Issue 072

Publication date: April 2022

ISBN: 9798400206313

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Topics covered in this book

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Inflation , Economics- Macroeconomics , Economics / General , Inflation , Sentiments , Expectations , Monetary Policy , inflation expectation , interest rate hike , sentiment shock , forecasted inflation , expectations multiplier , inflation impulse , Inflation , Neoclassical theory , Rational expectations , Vector autoregression , Machine learning

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Summary

The consensus among central bankers is that higher inflation expectations can drive up inflation today, requiring tighter policy. We assess this by devising a novel method for identifying shocks to inflation expectations, estimating a semi-structural VAR where an expectation shock is identified as that which causes measured expectations to diverge from rationality. Using data for the United States, we find that a positive inflation expectations shock is deflationary and contractionary: inflation, output, and interest rates all fall. These results are inconsistent with the standard New Keynesian model, which predicts inflation and interest rate hikes. We discuss possible resolutions to this new puzzle.