The anchoring of inflation expectations in the Czech Republic

Measuring inflation expectations is a standard analytical approach used by central banks, particularly in the inflation targeting regime. The anchoring of inflation expectations is a key condition for successful monetary policy. The CNB obtains information about inflation expectations by means of Financial Market Inflation Expectations (FMIE) questionnaires (monthly) and a survey of business managers (quarterly).

The indicator of financial market inflation expectations monitors the one-year and three-year horizons. At the three-year horizon this indicator has tallied quite closely with the inflation target in recent years, whereas expectations at the one-year horizon are very close to the weighted average of current inflation and the inflation target. However, this does not necessarily mean that financial market analysts produced their inflation expectations in this way. On the contrary, it can be viewed as confirmation of the credibility of CNB monetary policy, since markets believe that the CNB is able to return inflation to the target after an inflation shock. The best inflation prediction beyond the monetary policy horizon for the financial market is therefore the inflation target itself, as is apparent from Chart 1.

Chart 1 (BOX) Inflation expectations at the three-year horizon
Financial market inflation expectations for the three-year horizon are anchored at the CNB's inflation target; the inflation expectations of corporations are converging to the target from above
(year on year in %)

The inflation expectations of corporations have a similar profile to those of financial market analysts, but were typically higher between 2012 and 2015 – by 0.5 percentage point on average. The Czech Republic is not unique in this regard; international comparisons show that the inflation expectations of corporations and households are typically higher than financial market expectations.¹ However, the inflation expectations of corporations for the three-year horizon are close to the 2% target, which means that inflation expectations are correctly anchored at present for these entities as well.

An alternative to reported expectations is implicit inflation expectations derived from FMIE-based expectations of economic growth and wage growth. The difference between the two variables serves as an indicator of expected inflation for this reason: if productivity growth is mirrored with similar force in growth in real economic output and real wages, the difference between expected growth in nominal wages and real GDP reflects expected inflation. For headline inflation, this relation works quite well and the expectations derived in this way are a good indicator of future inflation at the one-year horizon. This was particularly apparent in 2014 and 2015, when implicit inflation expectations, unlike standard expectations obtained from the FMIE questionnaires, captured the low inflation, which was below the lower boundary of the tolerance band around the CNB’s target. Chart 2, depicting real inflation and implicit and standard expectations (shifted by one year), illustrates this. According to this indicator, expected inflation rises from very low levels in 2014–2015 and is inside the 2% tolerance band this year.

Chart 2 (BOX) Actual inflation and inflation expectations
Implicit inflation expectations are a good indicator of future inflation at the one-year horizon
(year on year in %)

Overall, therefore, the CNB’s inflation target is currently a good nominal anchor for both financial markets and corporations. The same applies to expectations implicitly derived from the expected growth of the real economy and nominal wages.

¹ Kliesen K. L. (2015). How Accurate Are Measures of Long-Term Inflation Expectations? Economic Synopses 15/09.