Inflation Targeting Does Not Anchor Inflation Expectations: Evidence from Firms in New Zealand

Abstract

We study the (lack of) anchoring of inflation expectations in New Zealand using a new survey of firms. Managers of these firms display little anchoring of inflation expectations, despite twenty-five years of inflation targeting by the Reserve Bank of New Zealand, a fact which we document along a number of dimensions. Managers are unaware of the identities of central bankers as well as central banks' objectives, and are generally poorly informed about recent inflation dynamics. Their forecasts of future inflation reflect high levels of uncertainty and are extremely dispersed as well as volatile at both short and long-run horizons. Similar results can be found in the U.S. using currently available surveys as shown in Binder (2015).

Monetary Policy Communications and their Effects on Household Inflation Expectations

“…Strikingly, almost forty percent answered that the Federal Reserve was targeting an inflation rate of 10% or more, which suggests a pervasive lack of knowledge on the part of households about the objectives of the Federal Reserve. This is consistent with previous evidence on the knowledge of households and firms in low-inflation environments about monetary policy , Kumar et al 2015, Cavallo et al 2017.…”

Measuring Inflation Anchoring and Uncertainty: A US and Euro Area Comparison

“…One popular measure is the response of inflation compensation measures (TIPS break-even rates of inflation swaps) or interest rates to incoming macroeconomic news (Gürkaynak, Levin, Marder, and Swanson, 2007;Mishkin, Introduction 2007;Beechey, Johannsen, and Levin, 2011;De Pooter, Robitaille, Walker, and Zdinak, 2014;Speck, 2016). Other measures include the response of (changes in) long-term inflation expectations to (changes in) short-term ones (Buono and Formai, 2016;Gerlach, Moessner, and Rosenblatt, 2017), the precision around estimates of the level of inflation (Mehrotra and Yetman, 2014), the volatility of shocks to trend inflation (Mertens, 2016), and the closeness of average beliefs to the central bank's inflation target (Kumar, Afrouzi, Coibion, and Gorodnichenko, 2015;Łyziak and Paloviita, 2016). …”

Inflation Expectations: Review and Evidence

“…under an inflation targeting regime. For example, even with an inflation targeting framework, expectations were not well anchored in New Zealand when forecasters did not understand the central bank's objective function (Kumar et al 2015). Inflation expectations in 10 advanced economies were not as well anchored during periods of persistently below-target inflation as during periods when inflation was close to target (Ehrmann 2015).…”

“…Although it has been used for research purposes, it has not yet been published(Arioli et al 2017). Some central banks (for example, those of China, Poland, and Romania) release survey results showing the percentage of respondents who expect inflation to change.4 In addition, Germany's Ifo Institute has provided data on five-year-ahead inflation expectations for more than 70 countries since the end of 2014.5 The International Monetary Fund's World Economic Outlook has the broadest country coverage of longterm inflation projections (39 advanced economies and 154 EMDEs).6 Kumar et al (2015) andKabundi, Schaling, and Some (2015) document that in New Zealand and South Africa, some firms do not understand the central bank's objective function. Hence, even if professional forecasters' expectations are well anchored by inflation targeting in these countries, the same is not…”