The Camp View of Inflation Forecasts: Analyzing sample moments of surveySome results:
forecasts, we derive disagreement and un- certainty measures for the short- and
medium term inflation outlook. The latter provide insights into the development
of inflation forecast uncertainty in the context of a changing macroeconomic
environment since the beginning of 2008. Motivated by the debate on the role of
monetary aggregates and cyclical variables describing a Phillips-curve logic, we
develop a macroeconomic indicator spread which is assumed to drive forecasters’
judgments. Empirical evidence suggests procyclical dynamics between disagreement
among forecasters, individual forecast uncertainty and the macro-spread. We call
this approach the camp view of inflation forecasts and show that camps form up
whenever the spread widens.
- Short-term expectations (1year) in euro area do not diverge very much (1,2-2,4%) and the divergence is rather stable (except for 3Q2009). The US displays a similar pattern of stability (1,7-2,6%). The range is wider in the US however. "Eye-catching is that disagreement is more distinct for the US than for the euro area across the entire sample," that is, 1999-2009. Due to the crisis, disagreement soared in both areas, more so in the US.
- Long-term expectations (5years) in the euro area are remarkably stable (1,8-2%). This is perfect! A+ for the ECB (relative to goal, I prefer another). Volatility in the US is higher and at a higher level. "Dispersion of 5-year point forecasts as measured by its standard deviation follows a similar pattern as its 1-year counterpart, albeit the latest available survey hints to rather stabilizing developments. In terms of the corresponding IQRs, [Inter Quartile Range] the data for the US point to ongoing disagreement about long-term inflation expectations with a peak in the third quarter 2009. The opposite holds for the euro-area survey according to which there is a clear consensus emerging between professional forecasters; form 2001 onwards, its IQR has steadily fallen and reached a low value of 0.1% on average." Thus, "long-term inflation expectations are more firmly anchored in the euro area than in the US."
It is at this point, I struggle with the paper even though I embrace any attempt to introduce heterogeneous believes, and even though I strictly believe in the persistence of misspecified models. Perhaps you guys can help me out. Here is my problem: Do you really mean that monetary thinking in the US is more 'monetarist' - in your terms - than in the Eurozone? Washington and New York have more monetarists than Frankfurt? Did all hillbillies entered the yankee-north, taking control over professional forecasting at Wall Street, etc? I know, many reasonable people have inflation-fears. But if they do because of being member of the monetarist camp you define, they simply produce sunspots (which is interesting in itself). I doubt that. Here my suggestions, starting with some introductory remarks:
- The first camp is called 'monetarist'. These camp members believe in a strong long-run link between narrow monetary aggregates (you use M1, base is also possible). Thus, they interpret the authorities' measures against the crisis as inflationary and adjust their expectations accordingly. Metzler is such a case in point.
- The second camp is populated by members thinking in terms of the Phillips curve (thus, PC camp). They focus on the output gap, being highly negative (the Great Recession), and adjust their expectations downwards. Alas, the disagreement widens as long neither of the two camps is insignificant (or dominant).
According to equation 8, MC members look at excess growth of narrow money over real growth, whereas PC member focus on the output gap to form price expectations. Since output gap is negative, whereas excess money growth is positive, changes in price expectations must diverge. Yet, in the theoretical short run (output gap not zero) also monetarist will expect quantity adjustments. Excess money growth does not necessarily increase inflation expectations over a 5 year range (instead expected real growth increases). This is particularly evident in face of the largest contraction in output since the Great Depression. In turn, the PC camp will never deny that as soon as liquidity preference returns to its normal levels demand increases as long as the central bank remains passive. Both camps know that at the moment and to the extent that velocity increases, nominal income will immediately follow! In the case of the PC camp, with lagging price adjustments, the output gap is expected to shrink and may overshoot if money is not adjusted. This implies an increasing price level, a move along the short-run Phillips curve. PC camp members increase long-run expectations as soon as velocity increases - shifting the curve - if they would expect, like the monetarists, the central bank to remain passive throughout.
If both camps share the same information about the employment level and level of excess capacity, both will expect the growth of nominal income to split into the same rates of growth and inflation over time. What makes a difference, are their empirical believes! Perhaps the camps just assume velocity to soar at different points in time? Perhaps they differ in their prospects for growth and employment? Most importantly, however, is that they may simply differ in their public choice perspectives, that is, both disagree on the willingness and ability of the central banks to become active and adjust money supply (or rather interest rates). Everybody, all members of all camps know that the monetary authorities can control nominal values if they only want to. To me, your data seem to suggest that if there are two camps, than between those who believe that the Fed will follow the Taylor-rule, and a growing number of people who doubt that large-scale adjustments won't introduce policy and thus discretion. This also fits much better the Metzler-story. In this respect, the missing explicit target of the Fed may be partly responsible for the better long-run expectation performance in the euro area.
Then, however, your equation 8 is misleading and the camp titles are misnomers. The spread defined by eq. 8 has to allow members of both camps to introduce short-run velocity adjustments into their models. Otherwise they were no monetarists or PC members. They would be something else. Further monetarist must be allowed to form expecations the same way PC members do: Calvo can live on both planets! In this case, however, the spread defined by eq. 8 turns zero! The two camps may mislead the reader and you unnessarily introduce into your really good paper all the clowds surrounding the age-old debates among quantity-theoretic and other camps. You may thereby invite misinterpretations. Further, if you retain the camps as they are, I would skip Metzler! He isn't described very well by the monetarist camp.