Inflation Expectations: Review and Evidence

Abstract

This paper presents a comprehensive examination of the determination and evolution of inflation expectations, with a focus on emerging market and developing economies (EMDEs). The results suggest that long-term inflation expectations in EMDEs are not as well anchored as those in advanced economies, despite notable improvements over the past two decades. Indeed, in EMDEs, long-term inflation expectations are more sensitive to both domestic and global inflation shocks. However, EMDEs tend to be more successful in anchoring inflation expectations in the presence of an inflation targeting regime, high central bank transparency, strong trade integration, and a low level of public debt.

From Low to High Inflation: Implications for Emerging Market and Developing Economies

“…Even during 2021, when inflation rose sharply, long-term inflation expectations remained steady in advanced economies (Figure 6a). In EMDEs, too, inflation expectations decreased markedly in the second half of the 1990s, and then remained broadly stable although with wide variation (Kose et al 2019; Figure 6b).…”

“…Mounting public and private debt in EMDEs in the past decade could weaken commitment to disciplined fiscal and monetary policy frameworks. EMDE sovereign credit ratings have continued to deteriorate, with some falling below investment grade, reflecting concerns about rising debt and deteriorating growth prospects (Kose et al 2019;Ha and Kindberg-Hanlon 2021). Populist sentiment could inspire a move away from prudent fiscal policies and disciplined monetary policy frameworks.…”

Cooperation of Ukraine with international financial partners in martial law

“…Strengthening legislation for monetary policy and bank supervision will help raise the credibility of macroeconomic frameworks and reduce the cost of policies to reduce inflation and maintain currency stability (Gill and Ruta 2022b). Exchange rate passthrough from depreciation to inflation tends to be smaller in countries with more credible, transparent, and independent central banks; inflation-targeting monetary policy regimes; and better-anchored inflation expectations (Ha, Stocker, and Yilmazkuday 2019;Kose et al 2019). Establishing and maintaining resilient monetary policy frameworks is especially important against the backdrop of the use of unconventional monetary policy tools-particularly asset purchases-by some ECA central banks.…”

Can this Time be Different? Policy Options in Times of Rising Debt

“…The benefits of stability-oriented and resilient monetary policy frameworks cannot be overstated. During episodes of financial stress, when EMDE currencies tend to depreciate sharply, strong monetary policy frameworks will be helpful not least because the exchange rate pass-through to inflation tends to be smaller in countries with more credible, transparent, and independent central banks; inflation-targeting monetary policy regimes; and better-anchored inflation expectations (Kose et al 2019). Flexible exchange rates can provide an effective mechanism for macroeconomic adjustment and help avoid currency overvaluations, as well as preventing the buildup of large currency mismatches on balance sheets-a common precursor of crises.…”