Tracking inflation expectations during surge and return to target
The European Central Bank presents a new statistical model that transforms infrequent survey data into a dense, monthly grid of inflation expectations. This method provides crucial insights into how forecasters adjusted their outlook during the 2021-2022 inflation surge.
Filling survey blind spots
Measuring inflation expectations is vital for monetary policy, influencing spending, investment, and price-setting.
While surveys offer direct insights, they are often infrequent or limited in forecast horizons.
The ECB's new statistical model addresses this by enriching information from surveys of professional forecasters, such as the ECB Survey of Professional Forecasters (SPF) and Consensus Economics.
By identifying statistical factors that explain forecast dynamics, the model estimates expectations at a monthly frequency for any future horizon, going back to 1999.
This allows for the construction of smooth, monthly curves of inflation expectations from one month up to ten years ahead, providing a more comprehensive view than raw survey data alone.
This enhanced data helps policymakers better understand how shocks feed into expectations.
Anchored expectations despite the surge
Applying the model to the 2021-2022 inflation surge reveals three key insights.
Forecasters initially underestimated both the scale and persistence of the inflation surge until it peaked.
Upward revisions to the 12-month outlook, pushing expectations above the 2 percent target, occurred only after Russia's invasion of Ukraine in February 2022.
Crucially, despite these near-term adjustments, medium-term expectations remained firmly anchored around 2 percent throughout the period.
Forecasters consistently projected a return to the target within two years, even at the peak of inflation.
This robustness of medium-term anchoring was instrumental in containing longer-run inflation pressures when the ECB began raising policy rates in July 2022, facilitating a quicker and less costly disinflationary adjustment.
A valuable tool for policy
This modeling approach represents a significant step forward in monitoring inflation expectations, offering policymakers a richer and more timely picture.
The ability to transform sparse survey data into a dense grid enhances the assessment of how shocks impact expectations and their anchoring.
While the model's reliance on historical co-movements has inherent limitations, its cross-validation with market-based measures, once adjusted for risk premia, strengthens its credibility.
This tool is particularly pertinent now, as renewed energy price pressures linked to geopolitical conflicts bring inflation expectations back into sharp focus for central banks.