Inflation Targeting and the Anchoring of Inflation Expectations in the Western Hemisphere

We investigate the extent to which long-run inflation expectations are well anchored in three Western Hemisphere countries-Canada, Chile, and the United States-using a high-frequency event-study analysis. Specifically, we use daily data on far-ahead forward inflation compensation-the difference between forward rates on nominal and inflation-indexed bonds-as an indicator of financial market perceptions of inflation risk and the expected level of inflation at long horizons. For the United States, we find that far-ahead forward inflation compensation has reacted significantly to macroeconomic data releases, suggesting that long-run inflation expectations have not been completely anchored. In contrast, the Canadian inflation compensation data have exhibited significantly less sensitivity to Canadian and U.S. macroeconomic news, suggesting that inflation targeting in Canada has helped to anchor long-run inflation expectations in that country. Finally, while the requisite data for Chile are available for only a limited sample period (2002-2005), our results are consistent with the hypothesis that inflation targeting in Chile has helped anchor long-run inflation expectations in that country as well. [PUBLICATION ABSTRACT]