Statistical Implications of Inflation Targeting
Chapter

Part III DERIVING MEASURES OF INFLATION AND INFLATION EXPECTATIONS FROM THE MARKET DATA

Author(s):
Carol Carson, Claudia Dziobek, and Charles Enoch
Published Date:
September 2002
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Introduction to Part III

These Chapters are focused on securities markets as a rich source of information for inflation expectations. A conclusion is that inflation-targeting countries will do well to study and analyze bond market data intensively.

Roger Clews (Chapter 11) points out that central bankers have never limited themselves to monetary data and have always looked at a full range of monetary and financial data, including bond yields. It was not until the early 1990s, though, that the Bank of England began to publish its analysis of bond yields and the implied information on price developments, an example of a more organized and focused way of handling information in inflation-targeting regimes. Clews also cautions against problems of “muddy averages,” which come about because bond markets generally are not arranged in a neat ranking of cash flows and maturities, and against other limitations of data that stem from the need to make assumptions in estimating yield curves. For example, the Bank of England’s experience is that investors are concerned with, and hence calculate prices over the period of, the next business cycle but not beyond.

Cedric Scholtes (Chapter 12) discusses the use of inflation-indexed bonds and the notion of break-even inflation used in trading, which, in principle, permit the direct observation of the market view of future inflation when compared with nominal or nonindexed bonds. This information supplements surveys and econometric forecasting approaches. However, as illustrated in the case of the U.K. index-linked gilts market, taxation, other rules and regulations, market structure, relative market size, and other institutional and technical issues influence the availability of data and the way in which they would be interpreted; the important role of pension funds is a case in point.

Edward Offenbacher and Meir Sokoler (Chapter 13) propose that the IMF’s Special Data Dissemination Standard (SDDS) be augmented to include additional data most relevant to each subscriber’s economic policy regime. As a case study, the authors review the experience in Israel, where inflation targeting was introduced as a strategy to bring down inflation—in contrast to most other inflation-targeting countries, which introduced inflation targeting after inflation had already stabilized. In that environment, data on bond yields have a number of special limitations—for example, the liquidity of CPI-indexed bonds fell significantly as inflation expectations declined. With reduced liquidity, the comparability of various bond instruments also falls. The chapter concludes that forecasts should incorporate liquidity in extracting inflation expectations. The authors also note that equity markets, options, and futures can be additional sources of information.

Gustavo Bussinger (Chapter 14) discusses forecasts of inflation produced by private forecasters as providing useful information for expectations of inflation. In Brazil, the central bank has developed a system of collecting and disseminating private market forecasts, and it publishes information on their accuracy and reliability, thus rewarding good forecasters. Analyzing the minutes of the monetary policy committee before and after inflation targeting was adopted, the author suggests that a significant shift took place from backward- to forward-looking policy analysis and data use.

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