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Dr Joshua Chan wins ARC discovery project to investigate inflation expectation modelling

ANU to improve inflation expectations analysis

7 November 2016

Dr Joshua Chan from the CBE Research School of Economics has won a grant worth more than $280,000 in the latest round of Australian Research Council (ARC) funding. The project, announced as part of the 2017 discovery projects by the ARC, will develop a new time series modelling to provide better measures of inflation expectation and inflation expectations uncertainty.

 The project takes a model-based approach and combines information in model-based estimates and direct measures of inflation expectations. 

 CBE communications sat down with Dr Chan to delve into the challenging world of monetary policy modelling.

How did this project come about?

Inflation has been remarkably low in most advanced economies since the Global Financial Crisis. One explanation is that inflation expectations have been subdued: when firms and employees expect future inflation to be low, they set prices and negotiate wages accordingly. Thus it would be useful to have a good measure of inflation expectations.

There are two broad categories of direct, non-model-based measures of inflation expectations: those based on (i) surveys and (ii) those derived from financial prices.

There are concerns that survey-based measures of inflation expectations might be subjected to systematic biases. In the US for each year between 2008 and 2014, year on year inflation in the core Personal Consumption Expenditures price index has run below the Survey of Professional Forecasters long-run forecast of 2 percent. This raises the concern that survey-based inflation expectations might have become disconnected from actual inflation.

Market-based measures reflect the collective actions of market participants. However, they represent not only the market participants' inflation expectations but also other factors that affect market prices. These market-based measures are generally volatile, and this leads Faust and Wright (2013) to conclude that ``while direct high-frequency market-based information is valuable, interpreting these spreads as pure measures of inflation expectations is wrong and potentially dangerous".

So how does your approach differ from previous modelling?

The overarching aim of the project is to develop new time series models to provide better measures of inflation expectations and inflation expectations uncertainty. The project takes a model-based approach and combines information in model-based estimates and direct measures of inflation expectations. In essence, it aims to view these direct measures of inflation expectations through the lens of an econometric model.

What impact on monetary policy do you expect to happen as a result of this project?

One concrete output from the project will be a better measure of inflation expectations that combines information from diverse sources. This will be useful in gauging the credibility of monetary policy and assessing future inflation pressure.

The ANU College of Business and Economics core value is to develop leaders who transform business, society and economies.

This research engages in issues central to the future stability of the Australian economy steering it towards increased productivity, growth and financial sustainability.

Updated:   2 March 2017 / Responsible Officer:  CBE Communications and Outreach / Page Contact:  College Web Team