Has the Anchoring of Inflation Expectations Changed in the United States during the Past Decade?

Abstract

high future costs of production. Similarly, consumers expecting prices to fall may delay their spending, reinforcing disinflationary pressures with the resulting lack of demand. Prior to the financial crisis, researchers found that the level and volatility of inflation expectations decreased dramatically from 1981:Q3 to 2008:Q2, suggesting investors' inflation expectations were well anchored (Clark and Davig 2011). But did their expectations remain anchored after the crisis, during a period of unconventional monetary policy? We use a model consistent with previous research to examine whether inflation expectations became unanchored after the crisis. Our analysis of three metrics of inflation expectations-their level, volatility , and persistence-suggests that the degree of anchoring deteriorated somewhat in late 2010, coinciding with the start of the second round of LSAPs, but has improved since then. Other rounds of LSAPs and the adoption of a formal inflation target are associated with better anchoring of inflation expectations to varying degrees. Finally, we find inflation expectations have remained well anchored more recently (2017:Q3), returning to their pre-crisis behavior. Section I defines the level, volatility, and persistence metrics as well as the data used to construct inflation expectations. Section II discusses the channels through which monetary policy can affect inflation expectations. Section III introduces a model for inflation expectations and analyzes how the Federal Reserve's monetary policy actions affected the anchoring of inflation expectations over the past decade. To evaluate the degree to which inflation expectations have been anchored over time, we first examine the level, volatility, and persistence that summarize their long-run predictive distribution. 1 These metrics allow us to quantify the degree to which inflation expectations are anchored. If the level of inflation expectations gets closer to the central bank's longer-run objective, for example, then inflation expectations are better anchored. If the volatility of inflation expectations declines, then inflation expectations are also better anchored. Finally, if unantici-pated shocks to inflation expectations have less persistent effects over the long run, then inflation expectations are better anchored. All three