Inflation, deflation, and uncertainty: What drives euro-area option-implied inflation expectations, and are they still anchored in the sovereign debt crisis?

Abstract

Reproduction permitted only if source is stated. Non-technical summary Research QuestionInflation expectations are important for gauging the effectiveness and credibility of monetary policy. Concentrating on the period of the sovereign debt crisis we look at the drivers and the anchoring of inflation expectations derived from inflation option data for the euro area. ContributionWe use a new data set on options on the euro area harmonized index of consumer prices to derive probability distributions of inflation expectations including uncertainty and asymmetry of market participants beliefs about the inflation outlook. For analyzing the changing effects of monetary policy announcements and macro news over the sample period from 2009 to 2013 we use a time varying event study framework. A third contribution is to compare option implied and statistical density functions to gain insight into deflation risk. ResultsInflation expectations show a decreasing mean but growing uncertainty especially since the intensification of the sovereign debt crisis in mid-2011. Around the same time the influence of monetary policy announcements on inflation expectations diminished. Tail events such as deflation although still contained became more probable. The impact of macroeconomic news to explain inflation probabilities overall decreased and shifted towards countries more affected by the crisis. Concerning the anchoring of inflation expectations the paper provides a twofold result: The mean and low sensitivity to actual news speak for anchored inflation expectations whereas the growing uncertainty reveals market participants concerns about possible extreme inflation or deflation outcomes in the future. ErgebnissëUber den Krisenzeitraum sanken die Inflationserwartungen der Marktteilnehmer deutlich. Gleichzeitig waren sie sich stärker uneinsüber zukünftige Inflationsszenarien, die Unsicherheit der Inflationserwartungen nahm zu. Der Einfluss von geldpolitischen Ankündigungen verringerte sich, der Effekt von makroökonomischenÜberraschungen ebenso. Letztere verlagerten sich außerdem auf das stärker von der Krise betroffene Italien. Die Wahrscheinlichkeit einer zukünftigen Deflation wurde höher eingeschätzt, sie ist zudem mit Indikatoren für Heterogenität im Euro-Raum wie Renditeeunterschieden von Staatsanleihen positiv korreliert. Der Mittelwert und die geringe Reaktion langfristiger Inflationserwartungen sprechen für weiterhin fest verankerte Inflationserwartungen. Gleichzeitig wird aber auch eine zunehmende Unsicherheitüber den zukünftigen Verlauf der Inflationsentwicklung festgestellt. Bundesbank Discussion Paper No 24/2014Inflation, deflation, and uncertainty: What drives euro area option-implied inflation expectations and are they still anchored in the sovereign debt crisis? * Michael Scharnagl Deutsche Bundesbank Jelena Stapf Deutsche BundesbankAbstract We tackle two questions in this paper: In the sovereign debt crisis, what moves the euro area inflation outlook and has the firm anchoring of medium to long-term inflation expect...

Three dimensions of central bank credibility and inferential expectations: The Euro zone

“…in how tightly they are anchored at that level." Similar …ndings were presented by Scharnagl and Stapf (2011), using a di¤erent methodology and data set, as well as van der Cruijsen and Demertzis (2011) who …nd that, on average, expectations of national in ‡ation rates appear to have become less anchored than expectations of Euro area average in ‡ation. Buono and Formai (2018), too, found that Euro area in ‡ation expectations became less anchored post-GFC.…”

The anchoring of inflation expectations in time and frequency domains

“…However, inflation expectations in the U.S. become less firmly anchored during the crisis. The results of time-varying event study regressions in Scharnagl and Stapf (2015) suggest that the reaction of inflation expectations to news for monetary policy announcements and macro variables ceases to be significant in 2011 and shows no increase since then. Ehrmann (2015) estimates the relationship between the revision in the inflation expectation and the surprise component contained in news releases.…”

The eurozone (expected) inflation: An option's eyes view

“…We calibrate a single model (a Gaussian 1st-order autoregressive process) for euro inflation by using swap rates and all liquid options (across different strikes and maturities). In doing so, we depart from the literature, that fits a density for each maturity independently (e.g., Smith, 2012; Kitsul and Wright, 2013; Scharnagl and Stapf, 2015;Fleckenstein et al, 2017). The main advantage of our full spectrum approach is that, from the Q dynamics we calibrate, it is possible to derive (in closed-form or by numerical integration) any inflation measure.…”