Long-run inflation expectations anchored more firmly in the euro area than in the United States

Meredith Beechey, Benjamin Johannsen, Andrew Levin, Wed, 10/24/2007

a

A

The United States and the euro area are economies of comparable size and openness; furthermore both the Federal Reserve and the European Central Bank (ECB) have a legal mandate to maintain price stability. Recent history of long-run inflation expectations suggests reasonably well-anchored expectations in both regions, however no studies to date have compared the recent evolution and dispersion across forecasters' long-horizon projections in the United States to those in the EU. The authors of CEPR DP6536 use daily evidence from financial markets and surveys, which reveal a substantially greater degree of forecaster disagreement about long-run inflation outcomes in the United States than in the euro area.

By using daily data on inflation swaps and nominal-indexed bond spreads for each region, the authors estimate the response of the compensation for expected inflation and inflation risk to the surprise component of macroeconomic news. The findings suggest that the reaction of euro area inflation compensation to news is concentrated in the first few years of the term structure. At long horizons, inflation compensation is insensitive to data surprises suggesting that inflation expectations are firmly anchored.

In contrast to the euro area, US long-run inflation compensation reacts to data surprises and these responses are not short lived and are thus not likely to be due to temporary fluctuations in market liquidity following news events. The evidence seems to suggest that a quantitative inflation target could help provide a firmer anchor for US inflation expectations. The ECB's policy communication strategy - which includes an emphasis on the goal of price stability and a fairly specific definition of the medium-term inflation objective close to 2% - has contributed to much less significant effects of macroeconomic data releases on forward inflation compensation.

DP6536 Are Long-Run Inflation Expectations Anchored More Firmly in the Euro Area than in the United States?

Journalists are entitled to free DP downloads on request; please contact [email protected]. To learn more about subscribing to CEPR's Discussion Paper Series, please visit the CEPR website.

URL:  http://www.cepr.org/pubs/new-dps/dplist.asp?dpno=6536.asp

Topics:  Monetary policy

Tags:  ECB, central bank communication, euro-area inflation, inflation compensation

CEPR Policy Research