(AGENPARL) – gio 23 marzo 2023 economies, since late 2021 most central banks have progressively tightened their
monetary policy response aimed at anchoring these expectations to central bank targets
is, in fact, key to minimising the risk of a wage-prices spiral that would lead to higher
as those caused by the major increase in gas prices in Europe over the last two years or
so. As an “external tax”, the consequent decline in the terms of trade cannot be undone
but instead should be rapidly absorbed, ideally redistributing it in order to protect the
recovering the losses in purchasing power generate the real risk of protracting the high
Therefore, the crucial question that central banks are facing today is what the most
appropriate conduct of monetary policy should be in these complex and highly uncertain
expectations in the monetary transmission mechanism. I will then consider the issues
related to their measurement and interpretation. In light of these theoretical and empirical
I thank Katherine Virgo and the International Atlantic Economic Society for the kind invitation to
deliver this lecture. For their very useful contributions and comments, I also thank Rebecca Kelly, Pietro
lags, to use Milton Friedman’s famous expression, and through a complex system of
channels known as the monetary transmission mechanism. While central banks’ actions
beliefs or predictions about the future evolution of prices.
Expectations, in fact, shape
dynamics. In response to the expectation that there will be a broad increase in the prices
of goods and services, for example, workers may pre-emptively request higher wages
In macroeconomic models, the role of expectations is typically summarised by the
so-called augmented Phillips curve. As is well known, while the original Phillips curve
examined the relationship between wage growth and unemployment in the UK in
main idea underlying this relationship is straightforward: in a booming economy, high
This relationship is obviously a reduced form of more structural ones modelling the
behaviour of business and labour in the determination of production, consumer prices
explicit indexation clauses) or at anticipating future price changes extrapolating them
from past data.
In this sense, the notion of an augmented Phillips curve was not
new, but the aspects that had been neglected before were the importance given to
forward-looking behaviour and, therefore, the role of expectations in shaping actual
Much has been added and debated over the last forty years, which I do not intend to
discuss here. As a general statement, however, I would say that, while the curve was “alive
For a discussion on the role of expectations in modern monetary policy, see Bernanke (2007), for the
United States, and European Central Bank (2021a), for the euro area.
See, among others, Klein and Goldberger (1955) and De Menil and Enzler (1972), as well as Ando and
See Phelps (1967), Friedman (1968) and Lucas (1976). For a modern perspective on the Phillips curve,
and kicking” from the 1950s to the late 1980s, since then there has been progressively
deep uncertainty as to its empirical relevance, possibly also due to the perceived
and labour markets (measured by the “output gap” or the deviation of the actual rate of
unemployment from its “natural” rate) is often considered to have occurred in the years
known as the “Great Moderation”, even if there appears now to be some evidence of a
In any case, the augmented Phillips curve remains a useful tool for policymakers, informing
is therefore examined with care, even if – especially in the case of the recent major
supply-side shocks – the attempts of wages to catch up with previous price “surprises”
especially for the setting and assessment of the monetary stance. In fact, although
money is normally borrowed and lent at a nominal interest rate, what matters most
for consumption and investment decisions is the real interest rate, namely the nominal
real rate is also often considered a crucial variable that should inform monetary policy
makers working towards maintaining price stability.
In particular, as consumption and
investment decisions span over longer horizons, it is suggested that central banks should
not only seek to set the current level of the short-term rate of interest but also monitor
long-term real interest rates. It goes without saying that, quite apart from its role as a
reference point, the natural rate of interest (like the natural rate of unemployment or the
potential level of output) is not observed and very hard to estimate with a reasonably
of the most appropriate stance for monetary policy. In general, credibility in its pursuit
to the central bank’s target, monetary policy can protect price stability from supply and
stimulated a wave of papers testing the decline (possibly to zero) of the slope of the Phillips curve.
See, for example, Coibion and Gorodnichenko (2015), Blanchard (2016), Del Negro et al. (2020) and
expectations underlies one of the most important developments in central banking over
the last few decades, namely the increasingly widespread adoption of the monetary
expectations is not simple. First, the large variety of data that has become available over
operators ? all have heterogeneous perceptions about the future dynamics of prices.
economic decisions and what their formation mechanism is, including which variables
in the last three decades, building on the seminal surveys and research produced after
World War II and until the 1980s. Notwithstanding the initial poor designs, the qualitative
(or “tendency”) rather than quantitative nature of many of the responses, the prevalence
of short time horizons and the lack of information other than the average of individual
expectations, many important insights have been obtained over the years. These ranged
from initial attempts to derive the best possible measures for modelling their formation
Among the best known were (and still are), for the United States, since 1946 the quantitative
Livingston Survey of professional economists and since 1948 the qualitative survey of
households conducted by the University of Michigan (which became semi-quantitative
in 1966 and fully quantitative in 1977). In Europe, the oldest surveys were the monthly
review of the tendency of entrepreneurs’ expectations undertaken since 1950 by the IFO-
Institute of Munich, and the twice-yearly semi-quantitative survey of Italian businessmen
conducted by the economic magazine Mondo Economico. In 1961, a monthly survey of
consumer expectations was instituted in the UK by the Gallup Poll, and in 1971 monthly
surveys of manufacturing enterprises of member countries started being co-ordinated
For early reviews of the literature, discussions of measurement problems, estimates of formation
surveys currently conducted among professional forecasters (the ECB Survey of
Monetary Analysts, the ECB Survey of Professional Forecasters, Consensus Economics,
Euro Zone Barometer, among the others), households (the ECB Consumer Expectations
professional forecasters and, more recently also the ECB Consumer Expectations Survey,
are mostly qualitative in nature, refer to relatively short horizons and to producer rather
than consumer prices. An exception in this respect are the surveys conducted by the Bank
of France and the Bank of Italy, which are at the forefront in the quantitative assessment
In what follows I will draw on results gathered by some of these
This is
very short term (one month) to the very long term (30 years), are a further source of
market-based expectations. An ILS is an agreement between two parties to swap, at a
Between survey- and market-based sources, the advantage of the former is that they report
the genuine expectations of participants directly, while the latter, as just mentioned, are
risk premia can be estimated on the basis of theoretical models, the uncertainty that
surrounds these estimates is usually non-negligible. In addition, surveys often include
main drawbacks of the surveys, instead, are related to their low frequency and the large
lags with respect to market data, which instead provide information continuously and
in real time. Another potential limitation is the relatively small size of the sample of
made with the Mondo Economico survey (see Visco, 1984). It was launched in 1999 and conducted
and, from 2018, by the Bank of Italy alone. The survey currently
participants and of the number of forecast horizons considered. The “quality” of the
Since the early 1970s, especially since what is known as the “rational expectations
revolution”, many studies have attempted to provide causal evidence on the extent to
In the past few decades, in particular, improvements in the availability of data have
prompted a proliferation of empirical studies on this issue, spurred on, too, by the fact that
monetary authorities have paid greater attention and devoted more time and energy to
expectations is not an easy task, as there are not many sources of exogenous changes
economic decisions, such as households’ consumption of durable and non-durable
their spending, in other cases it leads them to contract it.
for example due to a positive demand change as opposed to a negative supply shift.
expectations. In many models, the dominant approach relies on the full-information
rational expectations paradigm that became popular in the 1970s and 1980s, replacing,
to an extent, schemes that relied on (and at times tested) extrapolative, adaptive and
regressive mechanisms of the formation of expectations. Empirically, however, this
paradigm has had limited support throughout the years. According to some econometric
Even more recent
survey-based evidence appears increasingly at odds with the full-information rational
expectations paradigm: the presence of systematic biases in expectations; the predictability
forecast errors; the large amount of cross-sectional disagreement over future
of full rationality, such as their previous buying experience, their exposure to low or high
All these considerations led to a departure from the full-information rational expectations
paradigm only a few years after its ideation. A stream of studies has, in particular,
maintained the assumption of rational expectations but proposed deviations from the
full-information assumption due to data gathering and elaboration rigidities that naturally
create heterogeneity in beliefs. Examples are the sticky information approach, in which
agents update their knowledge infrequently because acquiring information is costly, and
the rational inattention approach, which instead assumes that agents actively decide not
to pay attention to all the news available to them. In this vein, at the end of the 1970s,
Cukierman and Wachtel developed a macro-economic framework in which expectations
Other authors have, instead, put aside the rationality assumption and incorporated the
insights gained from the behavioural economics literature resorting to forms of adaptive
learning. According to these scholars, agents experience cognitive limitations and thus
rely on ad-hoc forecasting models to form expectations that are updated in every period
using observed data, or embedding sources of systematic biases, such as optimism and
In light of the high uncertainty around the most appropriate approach for the analysis
the risks implicit in models that lead to a mechanical return to “normality” or to forms of
building on the aforementioned array of data available for the euro area. Short-term
their dynamics remain very volatile. The increase observed between February and the
premia (which tend to be larger at longer horizons), annual price changes should stand
This evidence is substantially in line with
what experts are saying. The results of the ECB Survey of Monetary Analysts conducted
conducted in early January, which signals that they have decreased slightly to 2.1 per
emerge from the ECB Consumers Expectations Survey (ECB-CES). However, the median
next 12 months and, despite the sharp decline from the previous round, at 2.5 per cent
A more granular analysis provides support to this conjecture, as it shows that the upward
In other
words, the observed higher expectations from household surveys may, in large part,
mirror what is happening in the energy and food sectors, and may therefore be subject
to reversal as soon as pressures on the price of these items decrease. The most recent
intentions to increase their own selling prices over the following three months fell in
the Bank of Italy reported, on the whole, forecasts of a deceleration in their sales prices,
still very high and turned to be a major extrapolative factor at that time. However, the
is somewhat reassuring evidence against the risk of de-anchoring, as medium- to
Close attention must indeed be paid not only to current levels of (short-term) price
(and wage) expectations, but also to their prospective dynamics. An assessment of the
risk of a de
current level could, in fact, be misleading. Since a de-anchoring could occur abruptly and
linearly, expectations must be assessed both in terms of their convergence towards
the price stability objective as well as their responsiveness to shocks and their dispersion.
On the one hand, expectations from market data and survey responses over the last
On the other hand, in many surveys
high consumer price changes and a rise in uncertainty, suggesting a greater, albeit still
Similar
to the unforeseen persistence of the energy shock over the last two years, they should
As I have recently observed,
policy) and short- to medium-term expectations, while still remaining very volatile, are
clearly on a downward trend. Similarly, the risk of wage-price spirals seems so far to be
contained, although the requests for elevated wage increases in some euro-area countries,
where the labour market is tighter, should be continuously and carefully assessed. In this
context, the pricing strategies of companies will also play a central role. In particular, we will
need to closely monitor whether, after the pass-through of the much higher energy costs
This section mostly follows two recent lectures given at the University of Warwick (Visco, 2023a) and at
the Frankfurt School of Finance & Management (Visco, 2023b). On those occasions, I also focused on
on how the Russian invasion of Ukraine transformed a temporary cost-push shock into a persistent
one, leading to an acceleration of monetary normalisation and on how the same dramatic event is at
to historical regularities. The results show that, since the start of the war in Ukraine, the
supply shocks; the much smaller contribution of demand shocks rose progressively over
the ECB’s monetary policy tightening is having, over time (and, I would add, with lags
recent drop in energy prices, in particular that of natural gas, as well as the loosening of
The monetary tightening is already having a clearly visible impact on credit and money
13 per cent last August, while loans to households also continued to decelerate. On the
other hand, M3 is slowing down markedly (3.5 per cent in January on an annual basis,
from 6.3 last September) and M1 growth became negative in January (-0.7 per cent, a
historical minimum). When assessed in real terms, the dynamics of both aggregates are
in deeply negative territory and at historical minima. If protracted, the fall in money, and
the related freezing of funds in more illiquid forms of savings, could limit consumption
This would further reinforce the reasons for a cautious conduct of monetary policy.
Indeed, while the Brainard principle states that when the central bank is uncertain about
an exception to this principle
entrenched in agents’ mind-sets.
While this possibility should be carefully monitored,
on a 3-month annualised basis observed since last October and the weakness of credit
the euro area and suggest a more gradual monetary normalisation.
In this respect, it will
cent symmetric medium-term target, a week ago, the Governing Council of the ECB
further raised its three key policy rates by 50 bps, bringing the overall increase since last
liquidity) to 3 per cent. Since the beginning of March, we have also been reducing the
assets held in the monetary policy portfolio at a measured and predictable pace, through
the partial reinvestment of the principal payments from maturing securities. This was
intended to ensure that the contribution of this monetary instrument is also aligned with
Looking forward, the Governing Council has reinforced the importance of a data-
dependent approach to the subsequent policy rate decisions, taking into account the
Council’s reaction function and its future decisions will be guided by the evolution of the
With risks to medium-term price stability increasing sharply in 2022, the pace and
right balance between two risks: the risk of stopping too early before the “job is done”,
wage setting processes, and that of overtightening monetary conditions, which would
the shocks generated by the dismal bank developments in the United States and in
Switzerland, and considering the substantial amount of tightening in the pipeline, a
stability are two strictly intertwined goals, as also the recent drop in market-based
Monetary policy, however, should not be, nor should it be perceived as being, the only
I stated at the beginning of this lecture must therefore be fully understood: the energy
shock is like a tax on the euro area economy, which unfortunately cannot be returned to
sender and cannot be circumvented through a fruitless race between wages and prices,
From this perspective, labour and business in all euro-area countries must continue to
behave responsibly. Wage negotiations should not go back in time to when they were
purely backward-looking. Making up for the loss of purchasing power must instead rely
on achieving sustained productivity growth. At the same time the pricing strategies of
businesses will play a central role. In particular, we will have to closely monitor whether,
after the pass-through of the higher energy costs observed in 2022, it will now work in
should not put the progressive reduction of public debt at risk, and avoid further
increasing its burden on the future generations. This is crucial not only to restore the
necessary conditions for robust and lasting growth, but also to guarantee a timely return
to the price stability target, the statutory objective of the central bank and an outcome
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Figure 1
Source: Eurostat, Istat, UK Office for National Statistics and US Bureau of Labor Statistics.
Note: EA denotes the euro area (changing composition after 1999 and weighted average of the 11 countries participating
Figure 2
Source: Bloomberg.
Figure 3
Long-term ination expectations in the euro area
Ination-linked swaps, 5-year, 5 years forward (1)
(monthly data)
Surveys among experts (2)
(quarterly and irregular data; median)
Note: (1) Ination expectations and ination risk premia are computed on the basis of the “tted” ILS 5-year, 5 years forward
Figure 4
Consumers’ ination expectations in the euro area
(monthly data; per cent; median)
Source: ECB Consumer Expectations Survey.
Figure 5
Firms’ pricing intentions in the euro area
(monthly data; percentages)
Source: European Commission.
Note: Pricing intentions refer to the balance of the responses “increase” and “decrease” to the question on expected own
price dynamics over the next three months.
Figure 6
Ination tail risks in the euro area
Survey-based probability distributions (1)
(ECB-SMA, long-term expectations; average)
Probabilities from ination options (2)
(daily data; 5 years horizon)
Note: (1) ECB-SMA “long term” is dened as the horizon over which the effects of all shocks will vanish and should be
Figure 7
Drivers of changes in ination expectations
(daily data; percentage changes)
Source:
Hoynck
and Rossi (2023)
Note:
5-year inflation swap rates;
changes with respect to 3 January 2022.
Figure 8
Credit and money growth in the euro area
Credit to rms
(3-month annualised percentage change)
(12-month percentage changes)
Source: ECB.