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Disinflation Expectations

Simon Wren-Lewis directed me to the Eggertsson & Woodford paper on “Optimal Monetary Policy in a Liquidity Trap“, which has way too much maths for this humble blogger.   But this bit I could understand:

Indeed, our most important general conclusion is that the key to dealing with a situation in which monetary policy is constrained by the zero lower bound on short-term nominal interest rates is the skillful management of expectations regarding the future conduct of policy. By “management of expectations” we do not mean that the central bank should imagine that with sufficient guile it can lead the private sector to believe whatever if wishes it to, independently of what it actually does; we have instead assumed that there is no point in trying to get the private sector to expect something that it does not itself intend to bring about. But we do contend that it is highly desirable for a central bank to be able to commit itself in advantage to a course of action that is desirable due to the benefits that flow from its being anticipated, and then to work to make this commitment credible to the private
sector.

Commenter “asdasdasd” on a previous post pointed out that inflation expectations were crashing.  I wonder if this is what Eggertsson & Woodford had in mind for “skillful” management of expectations?

Here is the data from May – the MPC decision to cease the QE program was announced on the 11th, and it was downhill from there:

UK Inflation Expectations

UK Inflation Expectations

The implied inflation data uses the RPI index, about 0.5%-1% higher than CPI.  The MPC have successfully compressed market inflation expectations for three years of sub-1.5% CPI growth.  Brilliant work.

HT: asdasdasd

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