We use novel, individual-level survey data across several countries to quantify inflation and deflationary biases in inflation expectations that emerge due to a loss in confidence in the central bank's price objective.


We develop a model that can accommodate both inflation and deflationary biases, and then test the model's prediction using the survey data. The model lets us dissect country-level results on inflation and deflationary bias and interpret them as a result of different perceptions of the target level of the output gap or different relative weights attached to output and inflation in the perception of the central bank's loss function. This feature is particularly useful for evaluating the differences in perceptions within the European monetary union.


Our results show that both inflation and deflationary biases are present and sizeable. For our sample of countries, we find that those that pursue inflation targeting have lower inflation expectations as well as lower dispersion of inflation expectations. However, our results also show that the deflationary bias may become even larger under an inflation targeting regime. 

Our results reveal substantial differences among European monetary union countries in terms of their perceptions of the ECB's objective function. The perception of the target level of the output gap, for example, is highest in Italy. The differences among other countries are mostly driven by the different relative weights attached to output and inflation. These results indicate that the ECB faces an ongoing challenge in convincing households of their objectives.



We explore the consequences of losing confidence in the price-stability objective of central banks by quantifying the inflation and deflationary biases in inflation expectations. In a model with an occasionally binding zero-lower-bound constraint, we show that both inflation bias and deflationary bias can exist as a steady-state outcome. We assess the predictions of this model using unique individual-level inflation expectations data across nine countries that allow for a direct identification of these biases. Both inflation and deflationary biases are present and sizable, but different across countries. Even among the euro-area countries, perceptions of the European Central Bank's objectives are very distinct.

JEL classification: E31, E37, E58, D84

Keywords:  inflation bias, deflationary bias, confidence in central banks, trust, effective lower bound, inflation expectations, microdata

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