The evolution of inflation expectations in Canada and the US

BIS Working Papers No 523
October 2015

We model inflation forecasts as monotonically diverging from an estimated long-run anchor point towards actual inflation as the forecast horizon shortens. Fitting the model with forecaster-level data for Canada and the US, we identify three key differences between the two countries. First, the average estimated anchor of US inflation forecasts has tended to decline gradually over time in rolling samples, from 3.4% for 1989-1998 to 2.2% for 2004-2013. By contrast, it has remained close to 2% since the mid-1990 for Canadian forecasts. Second, the variance of estimates of the long-run anchor is considerably lower for the panel of Canadian forecasters than US ones following Canada's adoption of inflation targets. And third, forecasters in Canada look much more alike than those in the US in terms of the weight that they place on the anchor. One explanation for these results is that an explicit inflation targeting regime (Canada) provides for less uncertainty about future monetary policy actions than a monetary policy regime where there was no explicit numerical inflation target (the US before 2012) to anchor expectations.

JEL classification: E31, E58

Keywords: Inflation expectations, decay function, inflation targeting