The Determinants of Time-varying Inflation Target Credibility

• Applicant: Professor Dr. Dieter Nautz
• Subject Area: Economic Policy, Applied Economics ; Statistics and Econometrics
• Term: since 2024
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 548833220

Numerical inflation targets play a key role in the communication and conduct of modern monetary policy. They clarify the meaning of price stability and can even anchor longer-term inflation expectations. However, inflation targets are effective only when they have sufficient credibility, meaning that enough people expect monetary policy to achieve the target. Therefore, the evolution of inflation target credibility perceived by consumers is of crucial importance for the effectiveness of monetary policy. The current project utilizes a unique and ongoing survey of German consumers designed to investigate the determinants of the time-varying credibility of the ECB’s inflation target. Central banks put a lot of emphasis on the exact definition of their target. An important innovation of the new monetary policy strategy of the ECB, introduced in July 2021, is the symmetric inflation target of 2%. According to the ECB, a symmetric target emphasizes that negative and positive deviations of inflation from the target are equally undesirable. We are therefore particularly interested in asymmetries in expectation formation since consumers may assess inflation rates below and above the target quite differently. In spite of their obvious importance, the wording of the inflation target plays no role in standard surveys of inflation expectations such that their implications for the credibility of the inflation target is not apparent. The qualitative survey used in the current project avoids these problems because the survey question and the available answer categories follow exactly the official definition of the ECB’s target. Our dataset contains more than 200,000 daily responses from approximately 130,000 German consumers (as of November 2023). Starting in January 2019, it enables us to estimate the effect of both positive and negative deviations of inflation from the ECB’s 2% target on the perceived credibility of the inflation target. While we control for personal characteristics of survey respondents, our primary focus is on analyzing the time-variation observed in inflation target credibility. By investigating the role of the inflationary environment and various measures of monetary policy in the perceived credibility of the inflation target, the project aims to improve central banks' expectations management and communication of monetary policy to a heterogeneous public.

• DFG Programme: Research Grants