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Formation of inflation expectations: Does macroeconomic and policy environment matter?

Author

Listed:
  • Eda Gulsen

    (Central Bank of Turkey)

  • Hakan Kara

    (Bilkent University)

Abstract
This paper investigates the changing behavior of inflation expectations in response to the macroeconomic and policy environment. Using a panel of professional forecasters covering thirteen years of inflation targeting period from Turkey, we present evidence on the behavioral shifts in the inflation expectations associated with evolving macroeconomic and policy performance. We use a unique survey with the feature of including matched policy rate and fixed-horizon inflation expectations at the individual level, therefore enabling to estimate the impact of monetary policy surprises on inflation expectations without reliance on strong identifying assumptions. Moreover, we employ a novel technique where direct feedback from survey respondents is used to determine the baseline empirical model governing expectations dynamics. Interpretation of the empirical findings joint with the direct feedback results from the survey indicate that the anchoring power of inflation targets depend on the policy performance. The weights attached to inflation targets in forming expectations are strongly associated with the size of the inflation deviation from the targets. When the targets no longer serve as a strong anchor, the survey participants assign increasingly higher weight to past inflation and the relationship between exchange rates and inflation expectations becomes stronger. Overall, our results imply that expectations behavior display significant and rapid shifts with the underlying economic and policy performance.

Suggested Citation

  • Eda Gulsen & Hakan Kara, 2020. "Formation of inflation expectations: Does macroeconomic and policy environment matter?," Koç University-TUSIAD Economic Research Forum Working Papers 2017, Koc University-TUSIAD Economic Research Forum.
    • Handle: RePEc:koc:wpaper:2017
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Inflation expectations; Monetary policy; Inflation; Survey data.;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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