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George Kershoff (Editor): BER

Pieter Laubscher: BER

Andrie Schoombee: Department of Economics, University of Stellenbosch

Stellenbosch

December 1999


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The results of inflation expectation surveys are mainly used in two ways, namely they serve as

inflation forecasts and central banks use them to evaluate the credibility of their inflation-fighting policies.

The results of direct quantitative inflation expectation surveys are a better measure of inflation

expectations than the results of qualitative surveys, such as that produced by means of the net

balance technique.

It is better to quiz various groups in society (such as business managers, households and fi-

nancial market participants), as the difference in their expectations reveal important informa-

tion on the future development of inflation.

A survey of the practices of central banks that consult inflation expectation surveys reveals the

following:

Most central banks make use of at least three surveys, which are mostly conductedamongst business people and consumers.

Broad-based surveys are far more commonly consulted than dedicated inflationexpectation surveys.

In all the surveys, the expected inflation figures or the percentage change in infla-tion (in terms of CPI) are required and not merely whether inflation is going to in-

crease or decrease.

Although the method used to gather the responses (postal questionnaires or tele-phonic interviews) and the size of the sample might have an influence, the re-

sponse rates of the inflation expectation surveys are generally low in the order of

25 to 35 per cent.

Quarterly surveys are more common than monthly surveys. Institutions release the results as they become available, but the results are gener-

ally made known at the same time in the case of surveys contracted specifically by

central banks.


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Introduction ...........................................................................................................1

What is inflation targeting?.....................................................................................1

How does a policy of inflation targeting work? ........................................................2

Reliance on forecasts................................................................................... 3

Use of inflation reports................................................................................. 3

Allowance for flexibility................................................................................. 4

Where do inflation expectation surveys fit in? .............. ............... ............... .............. 4

How are inflation expectations measured? .............. .............. ............... .............. ..... 7

Qualitative vs. quantitative measurement of inflation expectations................................ 7

Inflation expectations of various groups..................................................................... 8

Are the results of inflation expectation surveys of use for econometric forecasting? ......... 9

How are inflation expectation surveys conducted internationally? ................................11

Conclusions regarding the measurement of inflation expectations...............................15

Bibliography.........................................................................................................17


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The South African Government has recently decided to adopt inflation forecast tar-

geting as a framework for monetary policy. An inflation expectation survey is required to im-plement such a policy. The Reserve Bank has approached the Bureau for Economic Research

(BER) to conduct such a survey(s) on behalf of the bank. In order to provide the basis for an

informed discussion of the details of such a survey, the BER has reviewed the literature on the

subject and contacted central banks that implement inflation targets. The results of these re-

views and contacts are presented in this report.

The following topics are dealt with below:

What is inflation targeting? How does a policy of inflation targeting work? Where do inflation expectation surveys fit in? and How are inflation expectations measured?

The above serves as background to evaluate options available to South Africa to

measure inflation expectations. These options and their respective advantages and disadvan-

tages are presented in the last section of the report.

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In recent years, there has been a growing trend toward the adoption of inflation tar-

gets as the primary focus for the conduct of monetary policy. Countries that have adopted offi-

cial inflation targets in the 1990s include New Zealand, Canada, the United Kingdom, Swe-

den, Finland, Australia and Spain (IMF, 1996: 108). In 1998, the monetary policy framework

of 55 of the 91 countries that participated in the Bank of Englands survey could be charac-

terised as one of inflation targeting (Bank of England, 1999: 273).

Inflation targets are designed to help the central bank achieve long-run price stability

in three principal ways: by providing a nominal anchor for monetary policy, by improving the

transparency and accountability of monetary policy, and by enhancing the central banks in-

flation-fighting credibility. During the 1980s and 1990s, a number of countries abandoned

their traditional anchors, such as monetary aggregates and exchange rates. O ne reason was

that the relationship of monetary aggregates to economic activity broke down in many coun-

tries, leaving those central banks that targeted monetary aggregates relying more on discretion


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and looking at a wide range of information for guidance. Without an anchor, policy actions

can drift under the influence of short-run economic disturbance and, in the process, monetary

policy can develop an inflationary bias (Kahn & Parish, 1998: 6). Under an inflation targeting

regime the dynamic of the policy implementation process results in shifts from multiple and

shifting targets often under political control to a single, announced target with operational

responsibility delegated to an independent central bank (Sherwin, 1997: 266).

Explicit inflation targets play two main roles to reduce and control inflation: first, by

communicating to the public the objective that monetary policy seeks to accomplish, they serve

as a co-ordination device in wage and price setting processes and in forming the publics in-

flation expectations; and second, they provide a transparent guide to the conduct of monetary

policy, whose commitment and credibility can then be assessed on the basis of whether policy

actions are taken to ensure that targets are achieved (IMF, 1996: 108). For the public at large

and the financial markets, it is arguable whether the explicit inflation target has been the key

element in altering and anchoring inflation expectations, or whether it is the accountability and

transparency commitments of the central bank that has mattered more (Sherwin, 1997: 265).

According to Rudebusch and Svensson (1998: 1-2) inflation targeting is character-

ised by (1) a publicly announced numerical inflation target (either in the form of a target

range, a point target, or a point target with a tolerance interval), (2) a framework for policy

decisions which involves comparing an inflation forecast to the announced target, thus, pro-

viding an inflation-forecast targeting regime for policy where the forecast serves as an inter-

mediate target and (3) a higher-than-average degree of transparency and accountability.

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After comparing the monetary frameworks of four inflation targeting countries New

Zealand, Canada, Sweden and the United Kingdom Lafrance (1997: 254) concluded that in

each country the objective has been to maintain inflation, as measured by the percentage

change in consumer prices, at low levels within a fairly narrow range. Governments have sup-

ported these objectives, either explicitly or tacitly. Policy actions are forward-looking and based

on inflation projections, which range, in published form, from quite detailed (New Zealand

and the United Kingdom) to broadly indicative (Canada). While the move to explicit targets

has represented an important change in the monetary framework, the conduct of monetary

policy, in terms of policy instruments and the understanding of the transmission process of

monetary policy actions, has not changed radically in inflation targeting countries. While the


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goal of achieving a target rate of inflation provides a framework for and discipline on deci-

sion-making, the day-to-day conduct of monetary policy in the four countries remains discre-

tionary in nature. Inflation targets represent goals and not explicit rules for policy actions.

Many inflation targeting regimes share common features, namely reliance on fore-

casts, the use of inflation reports and allowance for flexibility.

Reliance on forecasts

Given lags in the effects of monetary policy on inflation, central banks seeking to

achieve a target for inflation need to forecast inflation and adjust policy to projected devia-

tions of inflation from target. Specifically, monetary policy actions generally affect output and

employment with lags of six months or longer and affect inflation with lags of 18 months andmore. As a result, policymakers take action based on forecasts of inflation one to two years

into the future. For example, if under the current setting of monetary policy instruments, infla-

tion is projected to rise above target one year from today, policymakers might need to take

action now to tighten the current stance of monetary policy (Kahn & Parish, 1998: 8).

Policymakers use a variety of methods to forecast inflation. They can look at private

forecasts, use information from financial markets (i.e. gauging inflation from long-term bond

rates), surveys of inflation expectations and make projections based on various econometricmodels of the economy. Whatever the approach, a necessary condition for the successful use

of inflation targets is that the central bank has some capability of forecasting inflation based

on the current stance of monetary policy (Kahn & Parish, 1998: 8).

Use of inflation reports

Most central banks that target inflation regularly issue an inflation report. The pur-

pose of the report is to explain what the central banks target is, describe how inflation has

behaved relative to its target and indicate where inflation may be headed in the future. Some

inflation targeting central banks actually publish their inflation forecast, as well as the risk sur-

rounding that forecast. The central bank may also use the inflation report to explain why a tar-

get may have been missed and what actions, if any, might be necessary to bring inflation back

to its target (Kahn & Parish, 1998: 8).


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Allowance for flexibility

Given the difficulty of forecasting inflation and the likelihood that many economic

shocks will have only temporary effects on inflation, all inflation-targeting regimes allow the

central bank to sometimes miss its target. When such misses occur, however, the central bankusually has to explain why (Kahn & Parish, 1998: 8).

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Changes in demand (such as a narrowing of the output gap) and supply conditions

(such as a sharp increase in commodity prices) usually are the initial causes of a rise in infla-

tion. This higher level of inflation, then, is mostly sustained by amongst other, inflation expec-

tations. Consumers, trade unions, producers etc. build these higher inflation expectations into

wage demands, asset prices and selling price.

How are these inflation expectations formed? From a theoretical view point, inflation

expectations are partially based on past values of inflation and partially on a rational assess-

ment of all factors influencing inflation (see box below).

The formation of inflation expectations: adaptive vs. rational expectations

Are peoples inflation expectations simply a projection of past inflation (i.e. they rely exclusively on past

levels of inflation to form an opinion of future inflation) or a rational prediction based on all information

available?

The adaptive expectation hypothesis (AEH) postulates that expectations of future inflation are based

solely on some distributed lag of past values of inflation. Business people often rely exclusively on past

data of the time series they predict, i.e. as if the past values of the indicator contains all the required

causal information in order to predict future values. People often ignore information that is logically

necessary to forecast the variable. Adaptive expectations are therefore often encountered in practice

(Wolter, 1993).

Proponents of the second view are adherents of the rational expectation hypothesis (REH). They believe

people are rational and will make use of all available information to make forecasts or when they form

expectations. In this way they will tend to eliminate any systematic errors, which could lead to bias in

their predictions. Expectations are therefore efficient (in as much they are using all available information)

and unbiased.

The main argument against the adaptive expectations hypothesis is the restriction that expectations are

formed by exclusively relying on the historic values of the time series concerned as if no other existing


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knowledge or any rational thoughts on the matter are taken into account when expectations are formed.

Gramlich (1983), for instance, found that money supply explains part of the variation in inflation ex-

pectations as represented by inflation expectation surveys. There are more studies finding statistically

significant variables explaining the variation in survey expectations (see Gramlich, 1983). In other

words, expectation formation does incorporate other existing information rather than only information

on past inflation. Roberts (1998) concludes: survey expectations are not purely adaptive.

The main critique against the rational expectations hypothesis, in turn, is the underlying assumption that

everybody has the cognitive or statistical abilities to form rational expectations and that full use is made

of existing information at the time of the expectation formation. Furthermore, no evidence exists that

peoples behaviour intuitively approximates the laws of statistics or economic rationality. Most of the

literature rejects the REH (see Gramlich: 1983). Roberts (1998) concludes: survey expectations are

not purely rational either . Batchelor (1986) has a problem with researchers basing their conclusions

on the analysis of qualitative expectation surveys. The problem is that qualitative surveys could be posi-

tively misleading in econometric testing of the nature of inflation expectation formation and can there-

fore not be used to ascertain the nature of inflation expectation formation. Evaluating direct quantitative

expectation surveys, however, he finds a higher degree of rationality in expectation formation.

The debate about adaptive and rational expectations is important when it comes to the prediction of

turning points and changes in an underlying variable. Models based on the adaptive expectations hy-

pothesis will always tend to miss the turning point with one or more periods while rational expectations

models assume that people would revise or adjust their expectations according to the error made in the

previous period. The idea of a learning process in expectation formation, therefore opens the door for

auto-regressive elements, so that a truly rational expectations model is also of an adaptive nature (see

Friedman, 1979: 32).

The major conclusion from the literature regarding theories on expectation formation is that neither

adaptive nor rational expectation hypotheses fully explain the formation of expectations. The adaptive

and rational expectation hypothesis should be seen as two extreme models and that the truth should lie

somewhere in between (Wolter, 1993: 5). Models incorporating both elements, i.e. an auto-regressive

component (extrapolative, adaptive or regressive expectations) and a rational component (expectations

as unbiased and efficient forecasts) perform best in explaining variations in expectations.

A survey of the literature on inflation targeting monetary policy frameworks and the inflation

reports of a number of central banks reveal that the results of inflation expectation surveys are

mainly used in two ways.

1. These results serve as inflation forecasts. Central banks use several forecasting techniques,such as econometric models, long-term bond rates and the results of inflation expectation


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surveys. The literature search did not reveal whether (if any) of these banks uses the results

of inflation expectation surveys as inputs in their econometric models.

2. Central banks use the results of inflation expectation surveys to evaluate the credibility oftheir inflation-fighting policies. A gradual narrowing of the gap between inflation expecta-

tions and actual inflation could indicate that the central bank convinced the general public

and financial markets of lower inflation. This gap will only narrow gradually, as inflation

expectations by nature have an adaptive and rational component. Furthermore, if a rise in

the inflation-fighting credibility of the central bank leads to a reduction in inflation expec-

tations and consequently actual inflation, the central bank would have been able to reduce

inflation without having to resort to restrictive monetary policies, which would have lowered

output and employment.

If consumers and business believe the central bank is committed to achieving

price stability, they will accept lower nominal wage increases, incorporate

lower inflation and inflation risk premiums into asset prices and be more will-

ing to make long-term commitments based on economic fundamentals instead

of inflation expectations. This credibility effect can help reduce the output

loss that typically accompanies disinflationary monetary policies (Kahn & Par-

ish, 1998: 7).

The issue of the credibility of monetary policy is crucial. If actual inflation and ex-

pected inflation is the same, then the presumption is that society reaches a better economic

outcome. Multi-period or even single-period labour and debt contracts are based on inflation

expectations. When expected and actual inflation are equal, then participants in contracts

carry out the transaction as anticipated when the contract was signed. If a central bank is able

to achieve its target rate of inflation and this target rate of inflation is the expected rate of in-

flation, then there are more periods when actual inflation equals expected inflation and societygets a better economic outcome (Johnson, 1997: 361).

The central bank could put its credibility at risk if it does not adequately foresee

changes in inflation. Central banks that adopted inflation targets, therefore, invest heavily in

improving their forecasting capacity and technology (Sherwin, 1997: 271).

If a central bank is worried that its policy suffers from low credibility (which is usually

the case directly after the introduction of inflation targets), this ought to affect the speed with

which the repo rate is cut for example. Drastic cuts can lead to an increase in inflation expec-


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tations, affecting the room for further cuts. In this case the central bank may have to keep its

policy interest rate higher than the forecast would seem to require (Heikensten, 1997, 287).

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QQQQUALITATIVE VSUALITATIVE VSUALITATIVE VSUALITATIVE VS.... QUANTITATIVE MEASUREMENT OF INFLATION EXPECTATIONSQUANTITATIVE MEASUREMENT OF INFLATION EXPECTATIONSQUANTITATIVE MEASUREMENT OF INFLATION EXPECTATIONSQUANTITATIVE MEASUREMENT OF INFLATION EXPECTATIONS

As a starting point, we have to distinguish between qualitative and quantitative meas-

urement of inflation expectations. The so-called net balance statistic is the most commonly ap-

plied qualitative survey method. Survey respondents simply have to indicate whether a par-

ticular variable was up, the same or down compared to some reference period. By sub-

tracting the proportion of the respondents that answered down from the proportion that an-

swered up , a net balance value is obtained, which in theory should reflect the respon-

dents underlying mean expectations. The Carlson-Parkin method of quantification is slightly

more complicated. See Batchelor (1986) and Foster and Gregory (1977). In the case of the

quantitative measurement of inflation, respondents have to supply the percentage change in

inflation, mostly as measured by the CPI.

Batchelor (1986) analysed the University of Michigans Institute of Social Researchs

(ISR) quantitative and qualitative consumer survey results between January 1978 and January

1984. The quantitative mean of inflation expectations obtained from the direct quantitative

survey of inflation expectations appears to be a more rational predictor of actual inflation

compared to the results of the qualitative surveys. Qualitative inflation expectation surveys do

track year-to-year movements in actual inflation, but not month-on-month changes.

The net balance statistic is more erratic and correlates poorly with both the level and

changes in quantitative measures of inflation expectations. Systematic errors occur at times,

i.e. errors in one month are carried over to the following, when net balance statistics are used

to estimate the mean inflation expectation of the population. Net balance statistics are also

biased when inflation expectations or uncertainty is high. They tend to underestimate the level

of inflation expectations and uncertainty, and vica versa (Batchelor, 1986).

According to Batchelor (1986), better quantification techniques of qualitative survey

results first need to be developed before they can be used as indicators of inflation expecta-

tions in an econometric model. Alternatively, it might be more useful to conduct direct quanti-

tative inflation expectation surveys.


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IIIINFLATION EXPECTATIONS OF VARIOUS GROUPSNFLATION EXPECTATIONS OF VARIOUS GROUPSNFLATION EXPECTATIONS OF VARIOUS GROUPSNFLATION EXPECTATIONS OF VARIOUS GROUPS

An important issue in the direct measurement of inflation expectations pertains to the

responses of various response groups, e.g. households, businesses and professional forecast-

ers. Much work has been done on the expectation formation of different groups in society and

the results have been interesting and in some cases surprising.

Gramlich (1986), for instance, found USA households average forecasts of inflation

superior to those of professional economists. He analysed the results of the University of

Michigan ISR consumer survey and the Livingstone survey of economists forecasts. Roberts

(1998: 14) arrived at a similar conclusion. Furthermore, amongst consumers, the lower edu-

cated and poorer consumers inflation forecasts are superior to those of the higher educated

and higher income consumers.

Source: Survey of Consumers, University of Michigan

Englander and Stone (1989) show a further interesting result. An analysis of the in-

flation expectations of households (again the ISR consumer survey) and professional forecast-

ers (results from the Decision Makers Poll and the Blue Chip Consensus in the USA) indicates

that household inflation expectations differ in their impact from that of financial market partici-

pants and professional forecasters. Household inflation expectations have a strong bearing on


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movements in nominal wages, while the inflation expectations of economists and financial

market participants have a strong influence on interest rate determination.

The fact that consumers will tend to build their inflation expectations into wage bar-

gaining with employers, combined with the result that consumer expectation surveys explain

much of future nominal wage growth, suggests that the survey is a reliable indicator of the un-

derlying inflation expectations. Similarly, Englander and Stone (1989) find inflation expecta-

tions influence interest rate determination and that the financial market expectation surveys

accurately reveal these expectations.

AAAARE THE RESULTS OF INFLATION EXPECTATION SURVEYS OF USE FOR ECO NOMETRICRE THE RESULTS OF INFLATION EXPECTATION SURVEYS OF USE FOR ECO NOMETRICRE THE RESULTS OF INFLATION EXPECTATION SURVEYS OF USE FOR ECO NOMETRICRE THE RESULTS OF INFLATION EXPECTATION SURVEYS OF USE FOR ECO NOMETRIC

FORECASTINGFORECASTINGFORECASTINGFORECASTING????

Two questions are pertinent to the usefulness or rationality of expectation surveys:

1. Do surveys contain forward-looking information, i.e. do they reveal new information andnot just an extrapolation of the past?

2. Do expectation surveys reveal true expectations; i.e. do they succeed in measuring under-lying expectations?

To proponents of the adaptive expectation hypothesis, expectation surveys are of lim-

ited use since beyond information on past levels of the variable concerned they do not

contain additional information, which could improve the rationality of the forecast. Given its

major critique, i.e. the inefficient use of available information to predict, expectations surveys

to assist in inflation forecasting should therefore be handled with utmost care (Wolter, 1993).

Adherents of the rational expectation hypothesis also distrust expectation surveys,

however, for a different reason. They argue that survey participants do not necessarily reveal

their true expectations. Experience with business surveys, however, shows that the overwhelm-

ing majority of participants have a direct interest in the actual survey results. Respondents

therefore have no interest in giving wrong answers (Wolter, 1993: 10). Englander and Stone

(1989) also find that in three inflation expectation surveys conducted in the USA1, the surveys

are accurate indicators of the respondents expectations upon which they tend to act.

1 The University of Michigan consumer survey; the Decision-Makers Poll amongst financial market participants and

the Blue Chip Consensus, mainly amongst professional forecasters.


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Analysts disagree widely on the usefulness of expectation surveys. Researchers even

come to opposite conclusions using the same survey results. See Gramlich (1983) and Roberts

(1998)2. It is clear that the various econometric tests applied to evaluate the rationality of sur-

vey expectations are very sensitive to the researchers assumptions. See an overview by

Croushore (1997) of various tests on the Livingstone survey of professional forecasters.

Most analyses of inflation expectation data reject the rational expectations hypothesis.

A large component of inflation expectation formation appears to be backward looking; i.e.

inflation expectations are to some extent shaped by past levels and changes in inflation. The

fact that a large part of expectation formation in practice is dominated by an extrapolative or

adaptive component, raises serious problems for the use of direct survey measures on expec-

tation formation. However, Wolter (1993) concludes: surveys will continue to constitute an

important means of obtaining a realistic and enhanced picture of expectation formation

(Wolter, 1993: 18). Roberts (1998) concludes: I find that the surveys [of inflation expecta-

tions] reflect an intermediate degree of rationality: Expectations are never perfectly rational or

as unsophisticated as simple auto-regressive models would suggest.

Models incorporating both a distributed lag on past inflation and expectations data

therefore fare best in predicting inflation. Expectation surveys do contain important future in-

formation. Its role in nominal wage growth and interest rate formation is, for instance, highly

significant (Englander & Stone, 1989). Volatile and unpredictable movements in food and en-

ergy prices explain much of the bias and systematic error in inflation expectations. Inflation

expectation surveys are better predictors of core inflation (Englander & Stone, 1989). This im-

plies that when the primary sources of changes in inflation are related to normal business cycle

and labour market forces, surveys perform better in predicting inflation. Croushore (1997: 8)

makes the point that most of the problems with inflation expectation surveys developed during

the 1970s and early 1980s when the oil price shocks led to significant bias and inefficiency

in survey expectations of inflation. More recently, the Livingstone survey forecasts show less

systematic error. Croushore (1993: 10) made similar conclusions regarding the Survey of

Professional Forecasters (SPF).

2 The University of Michigan ISR consumer survey, inter alia, tracking households inflation expectations, are found

to be an unbiased predictor of inflation over a 12 month period. However, the unbiasness deteriorates over themid- to late 1980s (Englander & Stone, 1989). The Livingstone survey of professional economists (Roberts,1998 and Gramlich, 1983) and the business survey run by the BEA (Gramlich, 1983) are found to be a biasedpredictor of inflation.


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HHHHOW ARE INFLATION EXPECTATION SURVEYS CO NDUCTED INTERNATIONALLYOW ARE INFLATION EXPECTATION SURVEYS CO NDUCTED INTERNATIONALLYOW ARE INFLATION EXPECTATION SURVEYS CO NDUCTED INTERNATIONALLYOW ARE INFLATION EXPECTATION SURVEYS CO NDUCTED INTERNATIONALLY????

The results of the survey of the international experience of countries where inflation expectation

surveys take place are summarised in the table below. Information on the following is pre-

sented in the table:

Which societal groups are targeted business people, professional forecasters, financialmarket participants, households or labour unions?

Which institutions conduct the surveys private non-profit business interest groups, publiclyfinanced research organisations or the central bank itself?

What methodology is used are qualitative or quantitative questions asked per postalquestionnaires, telephonic interviews or any other method? How are the questions

phrased?

What kind of surveys are used broad-based surveys of economic conditions and businessattitudes that include one or more questions on inflation expectations or targeted, custom-

ised surveys that serve exclusively to determine inflation expectations? Furthermore, did the

central bank specifically contract the survey to measure inflation expectations?

If available, information is provided on the size and composition of the sample or panel ofrespondents, the response rate, the frequency of the surveys (monthly or quarterly), the cost

and how the results are released.

The methods used by five countries Canada, New Zealand, Sweden, Australia and

the United Kingdom that adopted inflation targets and measure inflation expectations have

been considered in depth. The information has been obtained from journal articles, inflation

reports of the respective central banks and through contact with people at these banks. A

number of countries Israel, Czech Republic, Chile, Spain and Finland that also implement

inflation targeting have been left out due to a lack of information. Although the United States

does not follow an inflation targeting policy, it has been included, as there are many refer-

ences to their surveys in the literature. Furthermore, even though South Africa has not yet

adopted inflation targets, the country has been included. The next section options to meas-

ure inflation expectations in South Africa refers to this information.


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Country Target group Institution Methodology Broad based/ Targeted

Sample size ResponseRate

Households Inst. of AppliedEconomic & SocialResearch in Mel-bourne

Telephonic; ask opinion on current economic cli-mate. Q1 Expect prices to go up, down or remain thesame in a years time. Q2 What % expect prices torise/fall over this period?

BB Random sample of 1200 people

25%

Labour Un-ions

Australian Centrefor Industrial Rela-tions and Research

Telephonic; 10 questions are asked, Anticipatedinflation rate in 6, 12, 18 and 24 months time; aswell as wage expectations

BB Panel of union sec-retaries of top 22

trade unions

86%

Australia

Professionalforecasters

Reserve Bank Telephonic: inflation forecast for next 2 years T 15 priv. sector economists

N/A

Differentgroups

Barclays Survey ofInflation Expecta-tions (Basix)

Postal questionnaires; expectations of inflation 12 to24 months ahead, RPI inflation except for generalpublic, where measure is not specified

T Gen. public, TradeUnions, Fin. direc-tors, Bus. econo-mists, Investmentanalysis Academic

economists

N/A

Private busi-ness

Confederation ofBritish Industries(CBI) (Not for profitbusiness organ.)

Business tendency surveys; qualitative question onprice changes; no questions on inflation expectations

BB Manufacturers,Traders, Financial

sector

N/A

Private busi-ness

BCC Business tendency surveys; no questions on inflationexpectations

BB Service industry N/A

Households GFK and Mori Consumer confidence survey BB N/A N/A

United King-dom


Consensus Eco-nomics

Households Survey of consum-ers at Inst. for Soc.Research, Univer-sity of Michigan

Telephonic; expected % change in inflation over nextone and 5 years; part of consumer confidence sur-vey

BB 500 N/A

Households Conference Board,New York

Telephonic; expected % change in inflation, part ofconsumer confidence survey

BB 5000 N/A

USA (doesnot have aninflationtargetingmonetarypolicyframework) Professional

forecastersFederal Reserve,Bank of Philadel-

phia LivingstoneSurvey

Questionnaires; gathers quantitative forecasts of arange of macroeconomic variables

BB 50 - 90 economistslarge comp. (30%)

Investment banks(30%), comm.

banks (29%), aca-demics (13%), la-

bour, government &insurance (8%)

67%


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Country Target group Institution Methodology Broad based/ Targeted

Sample size ResponseRate


Federal Reserve,Bank of Philadel-phia Survey ofProfessional fore-casters (SPF)

Questionnaires; levels, change and probability forGDP, inflation, etc.

BB 36 in1993 N/A


Blue Chip EconomicIndicators (BCC)

Questionnaires; range of macroeconomic variables BB Sample size notknown, portfolio

managers, econo-mists, managers

N/A


Drexel, BurnhamLambert DecisionMakers Poll (DMP)

Questionnaires; range of macroeconomic variables BB 190 - 400professionals

N/A

Private busi-ness

Bureau for Eco-nomic Research(BER)

Postal questionnaires; business tendency surveys;qualitative data; expected change in rate of increaseof purchase prices

BB 814 Manufacturers;1050 Traders

40%46%

Households MRA AC Nielsen forBER

Personal interviews; consumer survey, no questionson inflation expectations included

BB 2500 households

Labour Andrew Levy & Ass. Postal questionnaires; & change in avg. wage set-tlements

BB 300 business enter-prises

N/A


US GraduateSchool / Beeld

Faxed questionnaires; % change in inflation andGDP one and two years ahead and one year aheadfor other variables e.g. PCE, current account, ex-

change rate, gold price, R153 and deposit rate

BB 29 fund managers,private and publicsector economists

100%


Reuters Faxed questionnaires; % change in headline CPI,core CPI, PPI, GDP, exchange rate, prime, BA andlong term bond rate for next 6 quarters and 2 years

BB 53 domestic andforeign fund man-agers and privatesector economists

Sept 99 31%

South Africa(does not yethave aninflationtargetingmonetarypolicyframework)

Fund manag-ers

Fleming Martin Faxed questionnaires; % of portfolio invested incash, bonds and equities; no questions on inflationexpectations

BB 22 Fund Managers N/A


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CCCCONCLUSIONS REGARDING THE MEASUREMENT OF INFLATION EXPECTATIONSONCLUSIONS REGARDING THE MEASUREMENT OF INFLATION EXPECTATIONSONCLUSIONS REGARDING THE MEASUREMENT OF INFLATION EXPECTATIONSONCLUSIONS REGARDING THE MEASUREMENT OF INFLATION EXPECTATIONS

The results of direct quantitative inflation expectation surveys are a better measure of infla-tion expectations than the results of qualitative surveys, such as that produced by means ofthe net balance technique.

It is better to quiz various separate groups in society (such as business managers, house-holds and financial market participants), as the difference in their expectations reveal im-

portant information on the likely future development of a number of economic variables,

such as inflation, wage increases and interest rates.

The major critique of proponents of the rational expectation hypothesis is that inflation ex-pectation surveys do not reveal respondents true expectations. However, research re-

vealed that if certain conditions apply, inflation expectations do indeed reveal the true ex-

pectations of respondents. Some of these conditions include the following:

A large and representative sample tends to reduce the possibility of sampling errors. Questions must be phrased neutrally to avoid bias in the survey responses. The timing of the survey is important. The questionnaire should be sent out so that all

participants have the same information available, i.e. the survey answers should be

returned before additional information on the variables surveyed becomes available.

Anonymity could improve surveys ability to truly reflect respondents expectations, as iteliminates the publicity effect. The publicity effect refers to individual forecasters that

tend to follow the consensus or tend to be bold in order to attract attention if the re-

sults are publicised.

The major critique of proponents of the adaptive expectation hypothesis is that inflationexpectation surveys do not reveal any new information. The same information can be

gauged from a simple extrapolation of the past. However, research has revealed that the

results of inflation expectation surveys do reveal extra information. The challenge is to

extract this extra information and include it in an econometric model to forecast inflation.

A survey of the practices of central banks that consult inflation expectation surveys revealsthe following:

Number of surveys and societal groups consulted: Most central banks make use of atleast three surveys. An equal number of surveys are conducted amongst business peo-

ple and consumers. These are also the most common groups to be surveyed. Surveys


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undertaken of other groups, such as professional forecasters, labour unions, private

sector economists and financial market participants, are less common.

Institutions contracted and scope of surveys: Broad-based surveys are far more com-monly consulted than dedicated inflation expectation surveys. Furthermore, all the

central banks make use of at least one broad-based survey. Surveys conducted by out-

side organisations are far more common than in-house surveys. O nly two of the five

central banks, namely that of New Zealand and Sweden, that consult surveys done by

outside organisations specifically contracted these organisations for this purpose.

Methodology: In all the surveys, the expected inflation figures or the percentagechange in inflation (in terms of CPI) are required and not merely whether inflation is

going to increase or decrease. The business tendency surveys mostly make use of

postal questionnaires. Most of the consumer surveys are conducted telephonically.

However, in some countries, other societal groups, such as business people, are also

surveyed telephonically. Telephone surveys are conducted over a period of 4 to 10

days. The numbers of respondents targeted in the telephone surveys, with the exception

of the ACIRRT survey in Australia and the one done for the Swedish Central Bank by

Statistics Sweden, are nearly double the numbers targeted in questionnaire surveys.

Response rate: The response rates are generally low in the order of 25 to 35 percent. No clear trend emerges when comparing telephone to questionnaire surveys, or

when comparing surveys conducted with businesses to those conducted with consum-

ers. It seems as though incentives, such as respondents receiving the survey results

prior to release to the market, fail to bring about higher response rates. In New Zea-

land, the response rate is dropping over time, although respondents receive the results

before being released to the market. Very high response rates (86% and above) are

achieved with the more focused telephone surveys undertaken by Statistics Sweden and

ACIRRT in Australia, even though no incentives are given for participating.

Frequency: Q uarterly surveys are more common than monthly surveys, in the vicinity of2:1. The monthly surveys are exclusively consumer surveys done by telephone.

Release of information: In the case of surveys contracted specifically by central banks,the survey results are generally made known to all interested parties at the same time.

There are two exceptions: the survey conducted with businesses in New Zealand (re-

spondents receive results first) and the one conducted by the Conference Board of

Canada with businesses (on-line subscribers receive the results first, then subscribers to

those reports and finally, the media).


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BBBBBBBBBBBBIIIIIIIIIIIIBBBBBBBBBBBBLLLLLLLLLLLLIIIIIIIIIIIIOOOOOOOOOOOO GGGGGGGGGGGGRRRRRRRRRRRRAAAAAAAAAAAAPPPPPPPPPPPPHHHHHHHHHHHHYYYYYYYYYYYY

Bank of England, 1999. The use of explicit targets for monetary policy: practical experience of

91 economies in the 1990s. Quarterly Bulletin August 1999. London: Bank of Eng-land. pp. 272-281.

Batchelor R A, 1986. Quantitative and qualitative measures of inflation expectations. Oxford

Bulletin of Economics and Statistics 48 (2). May 1986. pp. 99-120.

Croushore D, 1997. The Livingstone Survey: Still useful after all these years. Federal Reserve

Bank of Philadelphia Business Review. March/April 1997.

Englander A S and G Stone, 1989. Inflation expectations surveys as predictors of inflation and

behavior in financial and labor markets. Federal Reserve Bank of New York Q uarterly

Review 14 (3). Autumn 1989. pp. 20-32.

Foster J and M Gregory, 1977. Inflation expectations: the use of qualitative survey data. Ap-

plied Economics 9. pp. 319-329.

Friedman B M, 1979. O ptimal expectations and the extreme information assumptions of ra-

tional expectations models. Journal of Monetary Economis 5. pp. 23-41.

Gramlich E M, 1983. Models of inflation expectations formation. A comparison of household

and economist forecasts. The Journal of Money, Credit and Banking 15 (2). May

1983. pp. 155-173.

Heikensten L and A Vredin, 1998. Inflation targeting and Swedish monetary policy experi-

ence and problems. Sveriges Riksbank Q uarterly Review 4.

Heikensten L, 1997. Inflation targeting the Swedish experience. Paper delivered at the Bank

of Canadas 1997 conference Price stability, inflation targets and monetary policy

www.bank-banque-canada.ca/english/res/cn97e-6.htm. pp. 281-295.

International Monetary Fund (IMF), 1996. World Economic Outlook. October 1996. Wash-

ington DC: The Fund.

Johnson D, 1997. The credibility of monetary policy: International evidence based on surveys

of expected inflation. Paper delivered at the Bank of Canadas 1997 conference Price
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stability, inflation targets and monetary policy www.bank-banque-

canada.ca/english/res/cn97e-6.htm. pp. 361-370.

Kahn G A and K Parish, 1998. Conducting monetary policy with inflation targets. Economic

Review 83 (3). Federal Reserve Bank of Kansas City. Third quarter 1998. pp. 5-32.

Lafrance, R, 1997. Background paper: The Monetary Frameworks of four inflation-targeting

countries. Background paper to the Bank of Canadas 1997 conference Price stabil-

ity, inflation targets and monetary policy www.bank-banque-

canada.ca/english/res/cn97e-6.htm. pp. 245-260.

Roberts J M, 1998. Inflation expectations and the transmission of monetary policy. O cto-

ber1998. Washington DC: Federal Reserve System.

Rudebusch, G D and L E O Svensson, 1998. Policy Rules for Inflation Targeting. February

1998. Working Paper of the Sveriges Riksbank. www.riksbank.com.

Sherwin, M, 1997. Inflation targeting The New Zealand Experience. Paper delivered at the

Bank of Canadas 1997 conference Price stability, inflation targets and monetary

policy www.bank-banque-canada.ca/english/res/cn97e-6.htm. pp. 261-273.

Wolter S C, 1993. The use of survey results in respect to auto-regressive expectation forma-

tion. Paper presented at the 21st CIRET conference held by the Bureau for Economic

Research at Somerset West.
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