Are Long-Run Inflation Expectations Anchored More Firmly in the Euro Area than in the United States?

Abstract

This paper compares the evolution of long-run inflation expectations in the euro area and the United States, using evidence from financial markets and surveys of professional forecasters. Survey data indicate that long-run inflation expectations are reasonably well anchored in both economies but reveal substantially greater dispersion across forecasters' long-horizon projections of US inflation. Analysis of daily data on inflation swaps and nominal-indexed bond spreads, which gauge compensation for expected inflation and inflation risk, also suggests that long-run inflation expectations are more firmly anchored in the euro area than in the United States. (JEL D84, E31, E37, E52, E58)

Anchoring of inflation expectations in the euro area: Recent evidence based on survey data

“…Typically, de-anchoring risks are assessed by focusing solely on long-term expectations, but the responses of long-term inflation expectations to macroeconomic news have also been studied (see for example Beechey et al, 2011). A proper analysis of anchoring of expectations seems to us however more complex.…”

Are US inflation expectations re-anchored?

“…Galati et al (2011) estimate a single break (October 2008) in the newsregression and establish its significance using the endogenous break point test by 1 The non-response to news should be seen as a necessary but not sufficient condition for anchored inflation expectations. Alternative approaches assess the anchoredness of inflation expectations from different perspectives, including the level, volatility and persistence of inflation expectations, compare Beechey et al (2011) andStrohsal andWinkelmann (2014). News-regressions are estimated for changes of expected inflation implying that the level of expected inflation plays no particular role.…”

Inflation expectations, central bank credibility and the global financial crisis

“…Levin, Natalucci and Piger (2004) find that for the period 1994-2003 inflation targeting apparently played a significant role in anchoring long-term inflation expectations. Beechey, Johannsen and Levin (2011) establish that longterm break-even inflation rates, derived from the difference between nominal and real bond yields, and inflation swap rates seem to respond to macroeconomic news in the United States but not in the euro area, suggesting that credibility was weaker in the United States. Gürkaynak, Levin and Swanson (2006) show that forward break-even inflation rates far ahead in the United States seem to have responded to economic news and also in the United Kingdom before the Bank of England was made operationally independent, though not thereafter.…”

“…Mehra and Herrington (2008) study the impact of commodity prices on the same eight month-ahead US inflation expectations, from 1953 to 2007, and find that commodity price shocks seem to account for 11 to 22 percent of the variability of expected inflation post-1979, compared with 40 to 50 percent pre-1979. Beechey, Johannsen andLevin (2011) find that oil futures prices have affected long-term inflation swap rates and break-even inflation rates in the United States, but not in the euro area.…”