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Maintaining the Anchor: An Evaluation of Inflation Targeting in the Face of COVID-19

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Abstract

This paper provides evidence that inflation targeting delivered well-anchored inflation expectations during the post-2020 inflation surge. Using a macroeconomic model, we first illustrate how long-term nominal interest rates respond to an unexpected burst of inflation under both anchored and unanchored inflation expectations. Then, we evaluate these predictions using high-frequency financial market data from nine advanced economies. Specifically, we examine whether inflation expectations embedded in asset prices remained anchored as inflation climbed in the aftermath of the pandemic. Our results suggest that inflation expectations were just as well, or in some countries better anchored, after the pandemic. We show that this favorable outcome was broadly accompanied by perceptions of an aggressive monetary policy response to above-target inflation.

Suggested Citation

  • Brent Bundick & Andrew Lee Smith & Luca Van der Meer, 2024. "Maintaining the Anchor: An Evaluation of Inflation Targeting in the Face of COVID-19," Research Working Paper RWP 24-15, Federal Reserve Bank of Kansas City.
    • Handle: RePEc:fip:fedkrw:99296
    DOI: 10.18651/RWP2024-15
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    More about this item

    Keywords

    monetary policy; inflation expectations; COVID-19;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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