DP11535 Has Inﬂation Targeting Become Less Credible? Oil Prices, Global Aggregate Demand and Inﬂation Expectations during the Global Financial Crisis
Following the onset of the global ﬁnancial crisis (2008) we witness a strengthening of the correlation between crude oil prices and medium-term inﬂation expectations. Using the ﬁrst principal component of commodity prices as a measure for global aggregate demand, we decompose oil prices into a global demand factor and idiosyncratic factors that include supply side eﬀects and weather conditions. The decomposition of oil prices allows us to show that since the crisis, global ﬁve-year breakeven inﬂation rates react quite strongly to global aggregate demand conditions embedded in oil prices. The result suggests that market participants perceive inﬂation targeting as either less eﬀective around the eﬀective lower bound or less aggressive when inﬂation deviates below target. Alternatively, it may be that in recent years monetary authorities have additional considerations such as macro-prudential issues.