Ruhr Economic Papers

Ruhr Economic Papers #867

Inflation Expectation Uncertainty in a New Keynesian Framework

by Angela Fuest and Torsten Schmidt

RUB, RWI, 09/2020, 32 S./p., 8 Euro, ISBN 978-3-96973-004-1 DOI: 10.4419/96973004



For monetary policy guiding inflation expectations provides an instrument to achieve price stability. However, expectation uncertainty may undermine monetary policy’s ability to stabilise the economy. This study examines the effects of inflation expectation uncertainty on inflation, inflation expectations and the output gap by means of a structural VAR with stochastic volatility in mean. Inflation expectation uncertainty negatively affects the inflation rate and the output gap, without having a distinct effect on the level of expectations. This result is replicable with a model in which uncertainty is approximated by a cross-sectional survey measure. Furthermore, simulating an uncertainty shock in a DSGE model shows that the demand channel dominates the supply channel of an inflation expectation uncertainty shock.

JEL-Classification: E31, E52, C32, C63

Keywords: Uncertainty; inflation expectations; Phillips curve; New Keynesian model