Description

The consensus among central bankers is that higher inflation expectations can drive up inflation today, requiring tighter policy. We assess this by devising a novel method for identifying shocks to inflation expectations, estimating a semi-structural VAR where an expectation shock is identified as that which causes measured expectations to diverge from rationality. Using data for the United States, we find that a positive inflation expectations shock is deflationary and contractionary: inflation, output, and interest rates all fall. These results are inconsistent with the standard New Keynesian model, which predicts inflation and interest rate hikes. We discuss possible resolutions to this new puzzle.

More publications in this series: Working Papers

More publications by: Philip Barrett ; Jonathan J Adams