Inflation Expectations, Inflation Target Credibility, and the COVID‐19 Pandemic: Evidence from Germany

• Published date: 01 October 2023
• Author: WINNIE COLEMAN,DIETER NAUTZ
• Date: 01 October 2023
• DOI: http://doi.org/10.1111/jmcb.12998

DOI: 10.1111/jmcb.12998

WINNIE COLEMAN

DIETER NAUTZ

Ination Expectations, Ination Target Credibility,

and the COVID-19 Pandemic: Evidence from

Germany

Using the exact wording of the European Central Bank’s denition of price

stability,we started a representative online survey of German citizens in Jan-

uary 2019 that is designed to measure long-term ination expectations and

the credibility of the ination target. Our results indicate that credibility has

decreased in our sample period, particularly in the course of the deep reces-

sion implied by the Covid-19 pandemic. Interestingly,even though ination

rates in Germany have been clearly below 2% for several years, credibil-

ity has declined mainly because Germans increasingly expect that ination

will be much higher than 2% over the medium term. We investigate how

ination expectations and the impact of the pandemic depend on personal

characteristics including age, gender, education, and political attitude.

JEL codes: E31, E52, E58

Keywords: credibility of ination targets, Covid-19pandemic, expectation

formation, household ination expectations, online surveys

A     banks have published

quantitative denitions of price stability to improve the communication and account-

ability of monetary policy.Since 2004, the European Central Bank (ECB) has repeat-

edly emphasized that in the pursuit of price stability, it aims to maintain ination rates

Financial support from the German Research Foundation (DFG) through grant NA365/6-1 is gratefully

acknowledged. We thank Michael Ehrmann, Michael Weber, and an anonymous referee for useful com-

ments and suggestions. We also thank theC iveyteam for their support and for providing us with the data.

An earlier version of the paper circulated as FU discussion paper 2020/11: The time-varying credibility of

the ECB’s ination target: Newevidence from an online-survey

W C and D N are at the Department of Economics, Freie Universität Berlin

(E-mail: winnie.coleman@fu-berlin.de, dieter.nautz@fu-berlin.de).

Received March 17, 2020; and accepted in revised form June 10, 2022.

Journal of Money, Credit and Banking, Vol. 55, No. 7 (October 2023)

© 2022 The Authors. Journal of Money, Credit and Banking published by Wiley Periodicals

LLC on behalf of Ohio State University.

This is an open access article under the terms of the Creative Commons Attribution-NonCom-

mercial-NoDerivs License, which permits use and distribution in any medium, provided the

original work is properly cited, the use is non-commercial and no modications or adaptations

are made.

1938 :MONEY,CREDIT AND BANKING

below, but close to, 2% over the medium term. This denition of price stability plays

a central role in the communication strategy of the ECB.1Even during the Covid-19

pandemic, monetary policy measures of the ECB have been explained to the public

by the ultimate goal of steering too low ination rates in the Euro area back to the

below, but close to, 2% level. Yet, the impact of the pandemic on ination expecta-

tions seems to be at odds with standard economic theory. In the U.S., for example,

ination expectations of consumers signicantly increased at a time when the econ-

omy was headed to the largest recession in recent history, see Dietrich et al. (2022).2

The aim of our paper is to provide new evidence on the impact of the pandemic on

consumer ination expectations in Germany and, thereby, on the credibility of the

ECB’s ination target.

Direct evidence on the credibility of ination targets is surprisingly scant.3The

bulk of empirical literature evaluates a central bank’s credibility indirectly via the

anchoring of ination expectations. Since a credible ination target should an-

chor long-term ination expectations, the standard anchoring criterion is that ina-

tion expectations should not respond to economic news, forecast errors, or shocks

that are unrelated to the ination target. Following Gürkaynak, Sack, and Swan-

son (2005), it has been widely investigated whether and how expected ination

responds to surprises in macroeconomic news announcements.4While this litera-

ture provides important insights into the dynamics of ination expectations, the an-

choring criteria are only loosely connected to the precise denition of price sta-

bility used in monetary policy practice. For example, irrespective of their level,

constant ination expectations are always well anchored under the news crite-

rion. As a result, the degree of central bank credibility might be overestimated

in times when ination expectations are persistently above or below the ination

target.

1. On July 8, 2021, the ECB presented a revised strategyand dened the new, now symmetric ination

target to be “2% over the medium term.” Since our sample ends in May 2021, our empirical results are

not affected by the new target. According to Coibion et al. (2021), sophisticated modications of a central

bank’s ination target haveno signicant impact on the ination expectations of households.

2. Gorodnichenko shows that ination expectations of U.S. consumers have increased with Covid,

while those of professional forecasters decreased, see, for example, https://www.suomenpankki./

globalassets/en/research/seminars-and-conferences/ conferences-and-workshops/documents/cepr2020/

gorodnichenko–-bank-of- nland––sept-2020.pdf. We thank a referee for pointing this out.

3. Ehrmann, Soudan, and Stracca (2013), for example, analyze data of ECB trust taken from the Eu-

robarometer survey. Christelis et al. (2020) employ surveydata provided by the Dutch National Bank to

explore the inuence of trust in the ECB on ination expectations. For the United States, the Chicago

Booth Expectations and Communications Survey suggests that almost 40% of the respondents believe that

the Federal Reserve was targeting an ination rate of 10% or more, see Coibion, Gorodnichenko, and

Weber (2022).

4. Bauer (2015) and Nautz, Pagenhardt, and Strohsal (2017) employ news regressions to investigate

the anchoring of ination expectations in the U.S. and the Euro area. Hachula and Nautz (2018) estimate

the response of ination expectations to macroeconomic news shocks in a structural VAR model.