Formation of inflation expectations in turbulent times. Recent evidence from the European Survey of Professional Forecasters

This paper analyses formation of inflation expectations in the euro area. At the beginning we analyse forecast accuracy of ECB inflation projections relative to private sector forecasts. Then, using the ECB Survey of Professional Forecasters, we estimate a general model integrating two theoretical concepts, i.e. the hybrid model of expectations, including rational and static expectations, and the sticky-information (epidemiological) model. Among determinants of inflation expectations we consider – except backward-looking factors – rational expectations assumption and the effects of the ECB inflation projections. We examine whether ECB inflation projections are still important in expectations’ formation once the impact of forwardlookingness of economic agents has been taken into account. We also assess the consistency of implicit (perceived) inflation targets with the ECB inflation target. Our analysis indicates that recent turbulent times have contributed to changes in expectations’ formation in the euro area, as the importance of backward-looking mechanisms has decreased and the importance of the perceived inflation target has increased. We also find that the perceived inflation target has remained broadly consistent with the official ECB inflation target in the medium-term. However, the downward trend of the perceived target signals some risks of de-anchoring of inflation expectations. The importance of ECB inflation projections for mediumterm private sector inflation expectations has increased over time, but the magnitude of this effect is rather small. However, SPF inflation forecasts remain consistent with the ECB communication, being ether close to ECB projections or between ECB projections and the inflation target.