Study Questions Success of Inflation Targeting

Business managers are not getting the message about the Federal Reserve's inflation expectations, says a new study.
Matthew HellerSeptember 11, 2015
Study Questions Success of Inflation Targeting

Monetary policies designed to “anchor” inflation expectations may be having very little effect on business managers amid widespread ignorance about the operations of central banks and such policies as inflation targeting, according to a new study.

Central bankers have increasingly emphasized the importance of the public’s expectations, given that unanchored inflation expectations are commonly believed to have helped cause the spiraling inflation in the 1970s. To help shape expectations, they set inflation targets — in the U.S., the Federal Reserve’s current target is 2%.

But in a paper presented Thursday to the Brookings Institution, researchers from New Zealand and the U.S. say central bankers may have much less control over inflation expectations than they would like to believe.

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“In spite of a quarter century’s worth of central bank efforts to communicate inflation targets and shape public expectations, firms are no better than the general public in estimating inflation and often fail to incorporate recent inflation data into their business decisions,” the researchers conclude.

In New Zealand, where the research team interviewed managers at more than 3.000 firms, respondents have been forecasting much higher levels of inflation than has actually occurred and were generally ignorant of the operations of their own central bank. Only about one in every three New Zealanders correctly identified the heads of their central banks when presented with a list of four names.

“The U.S. public shows no more knowledge of monetary policy than that of New Zealand,” co-author Saten Kumar of the Auckland Institute of Technology told Bloomberg. Americans “are generally unable to identify recent inflation dynamics with any degree of precision.”

The paper, though, does not go so far as to say efforts to shape inflation expectations are doomed to failure.

“When firms without a strong understanding of the central bank’s objective were given information, nearly all managers reported some sensitivity to inflation expectations and they often made significant revisions to their inflation forecasts,” it notes, adding that if central banks can communicate more effectively with the public, “there will be indeed be [positive] economic repercussions.”