Inflation Expectations: Comparing the Predictive Power of Break-Even Inflation and Survey Expectations

University essay from Handelshögskolan i Stockholm/Institutionen för nationalekonomi

Abstract: This thesis compares the predictive power of different measures of expected inflation on actual inflation. In particular, we are analyzing whether brake-even inflation (BEI), i.e. the yield spread between real and nominal bonds, could be a more accurate estimate of future inflation than expectations derived from surveys. Our results indicate that neither BEI nor survey measures are reliable estimates of future inflation. Their predictive power, however, increases as inflation becomes more stable. Since the relative accuracy of the two measures differs between periods, we can not rank one measure over the other. In line with previous research, we find that BEI has become less volatile which could be interpreted as increased credibility for the central bank among financial actors. Finally, we find a large discrepancy in expected inflation between consumers and businesses. In almost each survey sample, consumers expected higher inflation than did businesses.

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