Oil prices, policy uncertainty and asymmetries in inflation expectations

The purpose of this paper is to investigate the possible asymmetric response of inflation expectations to oil price and policy uncertainty shocks.

The authors used the test of asymmetric impulse responses proposed by Kilian and Vigfusson (2011) to explore the issue of asymmetry.

Unlike other studies that assume symmetric effects, this study finds asymmetric effects of oil price and policy uncertainty on inflation expectations for positive and negative shocks and for pre- and post-financial-crisis periods. In particular other things being same, a same magnitude oil price shock has greater effect on inflation expectations in post-crisis period than in pre-crisis period. Moreover, in post-crisis period a positive increasing oil price shock has greater effect on inflation expectations than a negative decreasing oil price shock.

The paper concludes that FED’s greater focus on output stabilization since financial crisis has made inflation expectations less anchored and a sudden surge in oil price may quickly trigger inflation through inflation expectations.

Exploring the issue of the possible asymmetric effects of oil price and economic policy uncertainty on inflation expectations is a relatively new topic (as other studies only assumed symmetry and did not investigate the possible asymmetry in this regard).