The name of the rose
We recently published a report in which we argued that inertia in inflation expectations results, at least in part, from the Central Bank's own policy stance. By adopting a strategy that favors the slow convergence of inflation to the target, that is, over a period longer than the so-called "relevant horizon" (6 quarters ahead), the CB implicitly signals that the best expectation for inflation at the relevant horizon is no longer the inflation target itself, but rather a weighted average of current inflation and the target.
The longer the convergence period, the greater the weight attributed to current inflation in expectations formation, since agents know that inflation will remain above the target for a longer time. Thus, shocks that raise current inflation also tend to manifest in an increase in expected inflation at the relevant horizon and, depending on the speed of convergence, beyond it as well.
We also argued that, regardless of whether inflation expectations are at the target or above it, a slower convergence strategy implies lower disinflation costs in terms of the output gap; that is, it represents a dominant strategy from the standpoint of minimizing the short-term impact on the output gap. Knowing this, agents tend to form expectations above the target, characterizing an equilibrium that is difficult to break.
In this Special Report we present evidence suggesting that the Copom's current stance was adopted in a more explicit manner starting in 2023.
Now read on...
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