Expectations and Inflation: Evidence from the Euro Area, Japan, and the U.S

Modern economic theory underlines the importance of expectations. However, it is less obvious how expectations are formed and how they should be measured. This paper analyses the role of inflation and output growth expectations in the US, euro area and Japan. On the one hand, the question is how expectations affect both actual inflation and output; and on the other hand, how expectations reflect developments in these variables. The analysis makes use of atheoretical VAR models of actual inflation and output as well as inflation and output growth expectations, which allows for scrutinizing the dynamic interrelationships between these variables. The empirical results suggest that inflation expectations are the key ingredient of the inflationary process and that they have a significant negative effect on output. Inflation expectations are found to be relatively persistent – almost as persistent as output – albeit they do adjust to developments in both output and (actual) inflation, especially in the medium term.