Long‐term inflation expectations and inflation dynamics
Abstract After rising sharply following the Global Financial Crisis, inflation in Iceland has been low and stable in recent years despite a strong cyclical recovery. This not only reflects favourable external conditions but also coincides with a significant decline in long‐term inflation expectation...
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crwiley:10.1002/ijfe.2144 2024-09-15T18:13:25+00:00 Long‐term inflation expectations and inflation dynamics Pétursson, Thórarinn G. 2020 http://dx.doi.org/10.1002/ijfe.2144 https://onlinelibrary.wiley.com/doi/pdf/10.1002/ijfe.2144 https://onlinelibrary.wiley.com/doi/full-xml/10.1002/ijfe.2144 en eng Wiley http://onlinelibrary.wiley.com/termsAndConditions#vor International Journal of Finance & Economics volume 27, issue 1, page 158-174 ISSN 1076-9307 1099-1158 journal-article 2020 crwiley https://doi.org/10.1002/ijfe.2144 2024-07-04T04:28:48Z Abstract After rising sharply following the Global Financial Crisis, inflation in Iceland has been low and stable in recent years despite a strong cyclical recovery. This not only reflects favourable external conditions but also coincides with a significant decline in long‐term inflation expectations in financial markets. It is argued, however, that this market‐based measure of inflation expectations actually underestimates the true decline in long‐term inflation expectations of price setters. To extract this unobserved wedge between inflation expectations of price setters and financial agents, we estimate a time‐varying parameter Phillips curve model for the inflation‐targeting period since 2001, adjusting also for an unobserved risk premium in market‐based inflation expectations. The empirical results suggest that the expectations wedge was significantly positive until early 2012, after which it starts to gradually decline towards zero. The true decline in long‐term inflation expectations of actual price setters is, therefore, much steeper than is captured by the market‐based measure and taking this into account results in a stable and plausible specification of the Phillips curve that can explain key features of the recent inflation developments in Iceland. Article in Journal/Newspaper Iceland Wiley Online Library International Journal of Finance & Economics 27 1 158 174 |
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Abstract After rising sharply following the Global Financial Crisis, inflation in Iceland has been low and stable in recent years despite a strong cyclical recovery. This not only reflects favourable external conditions but also coincides with a significant decline in long‐term inflation expectations in financial markets. It is argued, however, that this market‐based measure of inflation expectations actually underestimates the true decline in long‐term inflation expectations of price setters. To extract this unobserved wedge between inflation expectations of price setters and financial agents, we estimate a time‐varying parameter Phillips curve model for the inflation‐targeting period since 2001, adjusting also for an unobserved risk premium in market‐based inflation expectations. The empirical results suggest that the expectations wedge was significantly positive until early 2012, after which it starts to gradually decline towards zero. The true decline in long‐term inflation expectations of actual price setters is, therefore, much steeper than is captured by the market‐based measure and taking this into account results in a stable and plausible specification of the Phillips curve that can explain key features of the recent inflation developments in Iceland. |
format |
Article in Journal/Newspaper |
author |
Pétursson, Thórarinn G. |
spellingShingle |
Pétursson, Thórarinn G. Long‐term inflation expectations and inflation dynamics |
author_facet |
Pétursson, Thórarinn G. |
author_sort |
Pétursson, Thórarinn G. |
title |
Long‐term inflation expectations and inflation dynamics |
title_short |
Long‐term inflation expectations and inflation dynamics |
title_full |
Long‐term inflation expectations and inflation dynamics |
title_fullStr |
Long‐term inflation expectations and inflation dynamics |
title_full_unstemmed |
Long‐term inflation expectations and inflation dynamics |
title_sort |
long‐term inflation expectations and inflation dynamics |
publisher |
Wiley |
publishDate |
2020 |
url |
http://dx.doi.org/10.1002/ijfe.2144 https://onlinelibrary.wiley.com/doi/pdf/10.1002/ijfe.2144 https://onlinelibrary.wiley.com/doi/full-xml/10.1002/ijfe.2144 |
genre |
Iceland |
genre_facet |
Iceland |
op_source |
International Journal of Finance & Economics volume 27, issue 1, page 158-174 ISSN 1076-9307 1099-1158 |
op_rights |
http://onlinelibrary.wiley.com/termsAndConditions#vor |
op_doi |
https://doi.org/10.1002/ijfe.2144 |
container_title |
International Journal of Finance & Economics |
container_volume |
27 |
container_issue |
1 |
container_start_page |
158 |
op_container_end_page |
174 |
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1810451182056898560 |