Inflation and Deflationary Biases in Inflation Expectations

Abstract

We explore the consequences of losing confidence in the price-stability objective of central banks by quantifying the inflation and deflationary biases in inflation expectations. In a model with an occasionally binding zero-lower-bound constraint, we show that both inflation bias and deflationary bias can exist as a steady-state outcome. We assess the predictions of this model using unique individual-level inflation expectations data across nine countries that allow for a direct identification of these biases. Both inflation and deflationary biases are present and sizable, but different across countries. Even among the euro-area countries, perceptions of the European Central Bank's objectives are very distinct.

Keywords: inflation bias, deflationary bias, confidence in central banks, trust, effective lower bound, inflation expectations, microdata

JEL Classification: E31, E37, E58, D84