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2017 | OriginalPaper | Chapter

29. Upside Risk Factors to the Inflation Outlook and Long-Term Inflation Expectations

Authors : Eliphas Ndou, Nombulelo Gumata

Published in: Inflation Dynamics in South Africa

Publisher: Springer International Publishing

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Abstract

This chapter explores the information content of long-term inflation expectations inferred from break-even inflation rates and the policy implications thereof. Evidence established that actual and counterfactual long-term inflation expectations are “poorly” anchored. Evidence reveals there is pass-through from positive long-term inflation expectation shock to headline CPI inflation. Long-term inflation expectations propagate the adverse inflation shocks into the real economy. Periods of heightened inflationary pressures result in elevated long-term inflation expectations. In policy terms, this suggests policy makers should adopt a policy stance that aims to break down such adverse reinforcing tendencies.

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previous chapter The Propagating Effects of Inflation Risk Factors and the Implications for the Inflation Outlook
next chapter Inflation Expectations, Adverse Aggregate Supply Shock and Long-Term Inflation Expectations
Footnotes
1
Bernanke (2003) defines well-anchored long-term inflation as those in which a one-off adverse shock to, for example, energy and food prices, does not lead to a permanent increase in inflation but only a change in relative prices. Similarly, if inflation expectations are well-anchored, changes in energy and food prices should have relatively little influence on core inflation.
 
2
In contrast to the traditional rational-expectations model of inflation and inflation expectations which implies that economic agents know the long-run equilibrium inflation rate. As such, their long-run inflation expectations do not vary over time in response to new information (Bernanke 2003).
 
3
The persistence of shocks matters.
 
4
The Banks’ quantitative definition of price stability refers to all-items headline inflation. However, the MPC does refer analyses the information contained in various measures of core inflation as operational guides for the policy stance.
 
5
Break-even inflation rates are computed as the difference between the nominal bond yield and the real yield (yield of the inflation-linked bond) can be decomposed into inflation expectations and related premia from financial market participants.
 
6
Hördahl (2008) finds larger risk premia for the euro area. As a result, the euro area adjusted break-even rate is also lower relative to the unadjusted rate. Furthermore the adjusted break-even rate is much closer to the survey forecasts than the unadjusted rate.
 
7
We also note that the BER five-year-ahead financial analysts’ inflation expectations are only available for the period starting 2011Q3. We are also cognisant of the weaknesses and criticism of survey-based inflation expectations. However, survey measures of inflation expectations are the main alternative source of information on inflation expectations for policymakers. Furthermore, they are not subject to inflation uncertainty, liquidity risk, and other risk factors embedded in break-even inflation rates (Christensen et al. 2004).
 
8
Counterfactual refers to long-term inflation expectation which exclude the contributions of expectations to long-term expectations.
 
9
This kind of communication is not very different to the previous “escape clause”.
 
10
Also known as the expectations trap hypothesis.
 
Literature
Bernanke, B. S. (2003). Before the money marketers of New York University, New York, New York, 3 February.
Christensen, I., Dion, F., & Reid, C. (2004). Real return bonds, inflation expectations, and the break-even inflation rate. Bank of Canada Working Paper 2004-43.
Christiano, L. J., & Gust, C. J. (1999). Taylor rules in a limited participation model. Working Paper Series WP-99-3, Federal Reserve Bank of Chicago.
Cogley, T. (2005). Changing beliefs and the term structure of interest rates: Cross-equation restrictions with drifting parameters. Review of Economic Dynamics, 8, 420–451.CrossRef
Honkapohja, S. (2015). Monetary policies to counter the zero interest rate: An overview of research. Research Discussion Papers 18/2015, Bank of Finland.
Hördahl, P. (2008). The inflation risk premium in the term structure of interest rates. BIS Quarterly Review, Bank for International Settlements, September.
Leduc, S., Sill, K., & Stark, T. (2002). Self-fulfilling expectation and the inflation of the 1970s: Evidence from the Livingston Survey. Federal Reserve Bank of Philadelphia, Working Paper No. 02-13.
Mishkin, F. S., & Schmidt-Hebbel, K. (2007). Does inflation targeting make a difference? National Bureau of Economic Research Working Paper 12876.
Metadata
Title
Upside Risk Factors to the Inflation Outlook and Long-Term Inflation Expectations
Authors
Eliphas Ndou
Nombulelo Gumata
Copyright Year
2017
Book
Inflation Dynamics in South Africa

Print ISBN: 978-3-319-46701-6

Electronic ISBN: 978-3-319-46702-3

Copyright Year: 2017

DOI
https://doi.org/10.1007/978-3-319-46702-3_29