Global inflation, inflation expectations and central banks in emerging markets

Summary

Focus

In 2021 and 2022, inflation saw a synchronised increase in both advanced economies (AEs) and emerging market economies (EMEs). The inflation surge, which was initially thought to be transitory, was later diagnosed as persistent, and short-term inflation expectations across AEs and EMEs saw significant upward revisions. In this context, we address two crucial questions: How has the sensitivity of inflation expectations to global inflation changed in EMEs recently? And how can EME central banks reduce the impact of global inflation on inflation expectations?

Contribution

We provide evidence of the effect of global inflation on domestic inflation expectations for different time horizons, and on both the mean and dispersion of forecasts from professional analysts. Also, we are the first to provide evidence of the sensitivity of inflation expectations to changes in global inflation after the Covid-19 pandemic, for both the mean and the dispersion, in addition to providing the first empirical evidence of the role of central banks in this regard.

Findings

We find that, after a decade-long stable trend, the sensitivity of short-term inflation expectations to global inflation has risen significantly since late 2021. Also, we find that while global inflation has more influence on the adjustment of professional forecasters' expectations in the short term, forecasters pay more attention to idiosyncratic factors for their long-term inflation expectations. Similar but less robust results are found for the dispersion of inflation expectations. Finally, we provide strong evidence that monetary policy can reduce the impact of global inflation on inflation expectations in both the short and long term, and on the dispersion between analysts' forecasts. This suggests that EME central banks have some leeway to manage inflation expectations, even when global factors are the primary source of inflation.

Abstract

This work studies the impact of global inflation on surveyed inflation expectations of private analysts in emerging market economies (EMEs), and the role central banks can play to lessen this impact. Our study uses quarterly data for 22 EMEs from 2000–23, focusing on the mean and dispersion of forecasted inflation expectations. We find three key results. Firstly, the global inflation component can affect the mean and, to a lesser extent, the dispersion of inflation expectations. For the mean of short-term inflation expectations, this effect increased in late 2021. Secondly, while the global inflation component does matter for short-term inflation expectations, the idiosyncratic inflation component (all the inflation variation that is not explained by the global component) has a stronger influence on longer-term inflation expectations. Finally, we find that monetary policy can help reduce the transmission of global inflation to inflation expectations in both the short and long term and on the dispersion of forecasters. This underscores that EME central banks have room to shape inflation expectations, even when global factors are the main cause of inflation.

JEL Classification: E31, E37, E52

Keywords: global inflation, inflation expectations, monetary policy