Oil prices, inflation expectations and monetary policy

The sharp declines in oil prices starting in late 2014 sparked a debate about their effect on inflation and the world economy (e.g. GEP January 2015). The decline in oil prices lowered inflation in the short run and in some cases pushed some economies that already experience very low inflation into deflation. More surprisingly, data from the US, Euro area, UK and Israel shows that oil prices have a strong correlation with inflation expectations for the medium term, as measured by five-year breakeven inflation rates. Before the global financial crisis this correlation was weaker and expectations were firmly anchored at the 2% level. However, from the onset of the global crisis, the correlation is quite high (Table 1 and Figure 1). In this note we decompose the change in oil prices to global demand and supply shocks. Using this decomposition we show that following the onset of the crisis inflation expectations reacted quite strongly to global demand conditions and oil supply shocks. These findings suggest that the public’s belief in the ability of monetary authorities to stabilize inflation at the medium term horizon has deteriorated. This could be due to A. greater emphasis put by monetary authorities on stabilizing economic activity as opposed to stabilizing inflation. B. Asymmetric behavior of central banks with respect to negative deviations from the inflation target. C. The public’s perception about the effectiveness of monetary policy around the zero lower bound.


Publication infos:
Jerusalem, Bank of Israel, 2015
Publication year:
2015
Number of pages:
13 p.
Collection:
Discussion Paper ; 09/2015
Record appears in:



 Record created 2019-06-28, last modified 2019-06-29

Fulltext:
Download fulltext
PDF

Rate this document:

Rate this document:
1
2
3
 
(Not yet reviewed)