Decomposing the Declining Volatility of Long-Term Inflation Expectations

FRB of Kansas City Paper No. RWP 09-05

31 Pages Posted: 26 Feb 2009  

Todd E. Clark

Federal Reserve Bank of Cleveland

Troy Davig

Federal Reserve Bank of Kansas City

Date Written: February 26, 2009

Abstract

The level and volatility of survey-based measures of long-term inflation expectations have come down dramatically over the past several decades. To capture these changes in inflation dynamics, we embed both short- and long-term expectations into a medium-scale VAR with stochastic volatility. The model documents a marked decline in the volatility of expectations, but also reveals a shift in the factors driving their movement. Throughout the 1980s and early 1990s, the majority of the variance in long-term expectations were driven by 'own' shocks. Beginning in the mid-1990s, however, the factors explaining the variance of long-term expectations began shifting amidst an overall decline in volatility. At the end of the sample in 2008, innovations to measures of inflation and output account for the majority of the remaining low-level of volatility in long-term expectations. We document a shift in monetary policy towards more systematic behavior that precedes the shift in the factors driving long-term expectations.

Keywords: Survey-based inflation expectations, stochastic volatility, Bayesian econometrics

JEL Classification: E31, E32, E52

Suggested Citation

Clark, Todd E. and Davig, Troy, Decomposing the Declining Volatility of Long-Term Inflation Expectations (February 26, 2009). FRB of Kansas City Paper No. RWP 09-05. Available at SSRN: https://ssrn.com/abstract=1349863 or http://dx.doi.org/10.2139/ssrn.1349863

Todd E. Clark (Contact Author)

Federal Reserve Bank of Cleveland ( email )

P.O. Box 6387
Cleveland, OH 44101
United States
216-579-2015 (Phone)

Troy Davig

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

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