INTERNATIONAL JOURNAL OF CENTRAL BANKING

Comments on“Did the Crisis AffectInflation Expectations?”by G. Galati, S. Poelhekke, & C. Zhou
Second IJCB Fall Conference
September 16, 2010

Shigenori SHIRATSUKA
Institute for Monetary and Economic Studies
Bank of Japan
Disclaimer: The views expressed are solely the responsibility of the presenter, and should not
be interpreted as reflecting the official views of the Bank of Japan.

0Summary• Question: The crisis affected long‐term
inflation expectations?
• Two Indicators for Long‐term Inf. Exp.:– Survey: Consensus Forecasts– Market: Inflation‐indexed bonds, Inflation swaps• Three Major Economies:– USA, Euro area, UK– Japan NOT included (presented at the BOJ)
S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 20101

Summary (Cont’d)• Econometric Analysis on Mkt‐based INF‐EXPIndicators:– Reaction to news about Inf. & other macro var.
– Controlling Mkt‐conditions• Conclusion: Less firmly anchored after theCrisis– More responsive to news after the crisis thanbefore

S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 20102

Overall Comments• An Important Question for CB Policymakers:– Did aggressive unconventional monetary policy
affect public expectations on long‐term INF‐EXP?

• Nice Trial by Using High Frequency Mkt Data:– Real time assessment of policy performance• Conclusion: Still Inconclusive– Destabilized F‐Mkt in the Crisis Æ Noisy Mkt data
– Difficult to get robust empirical evidence– Important: Design of empirical analysis
S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 20103

Empirical Framework• One‐year forward rates ending ten‐year ahead
as a Mkt‐based long‐term INF‐EXP.
Smoothed FRs using N-S modelf t ,10 = (1 + y10 )10Today(1 + y9 ) − 199‐year 10‐year

S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 2010

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Empirical Framework (cont’d)Explanatory variables: (but expected to be insignificant)News on macroeconomic variables (=difference between
actual release and ex‐ante survey)

Δf t = α + βX t + γZ t + ε tDependent variable:
First differences of Mkt‐based
long‐term INF‐EXP indicators Control variables for Mkt‐conditions:
VIX, Nominal bond volatility,….
Flight‐to‐quality Æ Negative impacts
S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 20105

Com‐1: Why Japan NOT Included?
Collapse ofInflation-indexedbond market

Relativechanges in
Mkt-liquidity

Heightened
deflationary
expectations?
ÆNOSource: Bloomberg
S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 20106

Com‐1 (cont’d)• To Get Robust Empirical Evidence:– Controlling Mkt conditions: Crucially important– How successful this paper?

• Estimates for Control Variables:– Most: Less statistically significant after the crisis– Some: Wrong signs after the crisis– Reliable enough?

• Empirical Strategy: Appropriate?
– Analysis for normal times, but not for crisis times?
S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 20107

Com‐2: Tested Hypothesis• How Firmly Are Inflation Expectations
Anchored?
• Analyzing reactions of INF‐EXP indicators tonews about Inf. & other macro var.
– Necessary condition– But sufficient condition?

• More Additional & Supplementary EmpiricalAnalysis(?)
S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 20108

Com‐3: Use of N‐S Model• Extended Nelson‐Siegel Model (Soderlind andSvensson, JME 1997 ):– Simple and parsimonious, but flexible enoughForward rates starting m‐period ahead:r (m) = β 0 + β1 ⋅ exp(−mτ1mmmm) + β 2 ⋅ ( ) ⋅ exp(− ) + β 3 ⋅ ( ) ⋅ exp(− )

τ1

τ1

τ2

τ2

• Two Features:– r(0) Æ β0+β1 and r(∞) Æ β0– Computing confidence intervals
S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 2010

9Com‐3 (cont’d)Yield Curve in Japan: January 29, 2003 with lowest β0

DATA:TIBORs 1‐12M
Yen swaps 2‐20Y

Source: Kunio Okina and Shigenori Shiratsuka, “Policy commitment and expectation formation: Japan’s experience under zero interest rates,”
North American Journal of Economics and Finance 15, 2004, pp. 75–100

S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 201010

Com‐3 (cont’d)• One‐year forward rates ending ten‐year aheadusing NS estimates:
1 10Y
f t ,10 = ∫ r ( s )ds
1Y s =9Y• Alternative Indicator:
β0 (long‐term forward rate)ÆBetter indicator for long‐term expectations• Compute confidence intervals
S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 201011

Com‐3 (cont’d)
Estimates of β0

S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 201012

Com‐4: Term Structure of INF‐EXP• Inflation Swaps & Indexed Bonds:– Data at wide range of maturities– Term structure of INF‐EXP• Dynamics of Term Structure of INF EXP– Responses to news at different maturities– Interaction b/w INF‐EXP at different maturities• N‐S Model: Very Convenient

S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 201013

Example: Japan’s YC Analysis• Effects of Policy Commitment on the Shape ofa YC Over Time Æ Policy duration effect• Two Episodes in Japan:– Zero Interest Rate Policy (ZIRP, from Feb 1999 toAug 2000): Commit to zero rate until deflationaryconcerns are dispelled– Quantitative Easing Policy (QEP, from Mar 2001 toMar 2006):Commit to CAB targeting until CPI
inflation becomes stably zero or above
S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 201014

Example
Indicators for policy duration effects
LFR= β0 = 2.8
PD=τ2= 1yＩnflection point:Local max of r'(m)of 4th term in r(m)Policy duration:
Min of 4th termin r(m)Slope of FR curve at 2*τ2
SL=arctan(r'(2*τ2))=39.5˚

Spot rate at PD: R(PD)=0.4

τ22∗τ2

S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 2010

Source: Okina and Shiratsuka (2004)

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Example (cont’d):
PD = τ2

Y2K

Source: Okina and Shiratsuka (2004)

S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 201016

Example (cont’d):
LFR= β0

Y2K

S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 201017

Example (cont’d):S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 201018

Conclusion• Tackled An Important Question for CB
Policymakers:– Did aggressive unconventional monetary policy
affect public expectations on long‐term INF‐EXP?

• Nice Trial by Using High Frequency Mkt Data,
But Still Inconclusive– Alternative empirical strategy?
– Designed for an analysis using data during a crisis?

S. Shiratsuka (BOJ) : Comments on Galati=Poelhekke=Zhou, IJCB Fall Conference on September 16, 201019