Inflation Expectations and Forward Guidance

Economics master project by Marc de la Barrera, Juraj Falath, Dorian Henricot and Jean-Alexandre Vaglio (Class of 2017)

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2017. The project is a required component of every master program.


Marc de la Barrera, Juraj Falath, Dorian Henricot and Jean-Alexandre Vaglio

Master’s Program:


Paper Abstract:

Our paper empirically investigates the impact of forward guidance announcements on inflation expectations in the Eurozone. The ECB first resorted to forward guidance on July 4, 2013 thereby expanding its array of unconventional policy instruments in the vicinity of the zero-lower bound. We use an ARCH model and identify forward guidance shocks as changes in the 2-year nominal ECB yield on specific announcement days to measure changes in daily inflation swaps of different maturities. In the process, we also separately identify the effect of quantitative easing and interest rate change announcement shocks. We find that forward guidance was successful in reviving inflation expectations in the medium to long term. Analyzing the transmission channels of forward guidance, we find evidence that both a reanchoring channel and a portfolio effect might have been at play.

Sources: authors’ calculations and Thomson Reuters Datastream


Forward guidance shocks have a strong impact on inflation expectations with a one point decrease in 2-year nominal ECB yields pushing inflation expectations 37bps upwards five years ahead with high significance. Normalizing, a negative shock of one standard deviation in ECB yields had a 11bps positive impact. In Campbell’s terminology (Campbell et al. (2012)), market participants’ interpretation was Odyssean. Thereby, we broadly match the results found by Hubert & Labondance (2016) for the Eurozone. Since the impact persists at all horizons, albeit with decreasing amplitude, we suggest that a reanchoring channel à la Andrade et al. (2015) explains the bulk of the transmission. ECB forward guidance announcements have thus been effective in reducing the growing gap between agents’ beliefs in future monetary policy and ECB’s targets. Our results are also consistent with a portfolio effect à la Hanson & Stein (2015). We also document that QE announcements were more effective in amplitude than forward guidance announcements, probably through a reduction in the term premium.

In contrast, studies run by Nakamura & Steinsson (2013) or Campbell et al. (2012) suggested a larger Delphic channel was at play in the US. More precisely however, they found that their results were lower than those predicted by a New Keynesian model with sticky prices. Thus, a natural extension of this paper would be to explore how our results would compare to the predictions of a New Keynesian model. Another approach would be to build a counter-factual for inflation expectations in the absence of forward guidance. In any case, given that the ECB implemented forward guidance at a time of heightened uncertainty and while long-term inflation expectations were dropping, there are reasons to believe it could have been more efficient in the Eurozone than in the US.

On the theoretical side, it is important to understand the transmission mechanisms of forward guidance within a structural model. This would allow to understand the potential gap to empirical outcomes. A number of authors have already striven to embed forward guidance within New Keynesian models and it is still an active area of research. The objective is then to derive an optimal policy function for further times of monetary policy management under the ZLB constraint.

To complete the policy recommendation, one needs to weigh out the benefits of forward guidance against its undesirable side-effects. Poloz (2014) suggested that successful forward guidance could results in increased future volatility when restoring conventional communication. Campbell et al. (2012) highlighted that central bank commitment could have a cost in terms of inflation or credibility. It would then be interesting to assess the negative externalities of forward guidance.


Andrade, P., Breckenfelder, J., De Fiore, F., Karadi, P. & Tristani, O. (2015), ‘The ECB’s asset purchase programme: an early assessment’, ECB Working Paper (1956).

Campbell, J., Evans, C., Fisher, J. & Justiniano, A. (2012), ‘Macroeconomic Effects of Federal Reserve Forward Guidance’, Brookings Papers on Economic Activity 43(1), 1–80.

Hanson, S. & Stein, J. (2015), ‘Monetary policy and long-term real rates’, Journal of Financial Economics 115(3), 429–448.

Hubert, P. & Labondance, F. (2016), ‘The effect of ECB Forward Guidance on Policy Expectations’, Sciences Po publications (30).

Nakamura, E. & Steinsson, J. (2013), ‘High frequency identification of monetary non-neutrality: The information effect’, NBER Working Paper (w19260).

Poloz, S. (2014), ‘Integrating uncertainty and monetary policy-making: A practitioner’s perspective’, Bank of Canada Discussion Paper (2014-6).

Barcelona GSE Trobada: The Future of Europe Roundtable – Politics (3/3)

The Political Future of the European Union

By Giacomo Ponzetto

The next session moved on to the political economy of the EU. Professor Ponzetto started his presentation by sketching the classical theory of fiscal federalism that gives insights on both the current state of the EU and its future.

This theory boils down to the trade off between the benefits of policy coordination and the costs of policy uniformity: is there too much (for example many economists agree that the agricultural pact went too far; the same goes for monetary union with less consensus) or too little (since there is a monetary union, fiscal union needs to be achieved) coordination in the current European framework? The cost-benefit analysis becomes even trickier when the size of the union kicks in: with whom should we coordinate? Is the European Union overstretched, should it continue to expand to new countries? Over time a neoliberal consensus has emerged, embodied by the research work of Alberto Alesina (1999, 2005), pointing at a union that is too small and homogenous. This union has also seized the control of too many policies: this research tells us that any decision maker will take control of a policy whenever he has the possibility, whereas some policies would be best kept off limits as voters do not necessarily agree to delegate them. Furthermore, no matter it does too much or too little, the European Union is doing it wrong according to this neoliberal consensus: the single market is too little enforced, and so are the public goods (failure of coordination of foreign policy, defense); on the other side, it does way too much redistribution and local public services.

Professor Ponzetto highlighted two different scenarios for the future of Europe in the context of global economic integration. In the continuity of Brexit, the first possible outcome is that globalization renders the EU irrelevant, up to its dissolution, since its main realization, the single market, loses its competitive advantage with rising global trade. Here members no longer need to bear the cost of uniformity. On the contrary, it could also strengthen the European Union thanks to the very same single market. It could be the appropriate tool to take advantage of rising trade opportunities and common economic regulation that fosters economic integration as noted by Gancia, Ponzetto and Ventura (2016). In any case, Brexit may offer a natural experiment to check which of these scenarios is correct. Looking at qualitative data published by the Pew Research Center before the vote offers a mixed picture: the short term agreement on an “ever closer” union looks is a stretch, while it could change in the long term as younger adults are more likely to favour the EU.


Source: Euroskepticism Beyond Brexit, Pew Research Center, June 2016

The presentation then turned to the topic that really complicates European Union’s relation to voters: shared responsibility and political accountability. In practice, the EU has exclusive control on a very limited number of policies. Though a flexible combination of European and national responsibility seemed beneficial (Alesina, Angeloni and Etro, 2005), it also generated opacity and loss of accountability (Joanis, 2014): who is responsible for policy outcomes? This question enabled politicians to blame the European Union and holding it responsible for any policy failure. As such, a better enforcement of accountability through clear delegated monitoring would be welcome. Boffa, Piolatto and Ponzetto (2016) found that differences in government accountability (for example Germany versus Italy) make the union more desirable by helping countries converge to the best practices. Political economy also tells us that a fiscal union does not seem very likely to happen for two reasons highlighted by Persson and Tabellini (1996): moral hazard in local policy (higher risk taking); and the fact that risk sharing entails redistribution (not in theory but always in practice). It also provides some other insights on the hostility to immigration through three factors: labour-market competition (see Professor di Giovanni’s presentation), pressure on the welfare state and xenophobia.

Gazing into his crystal ball, Professor Ponzetto concluded his presentation by reminding us that the EU remains very cautious and does not aim at grand reform. On the positive side, the single market will probably go forward and continue to deepen, in particular for the European financial markets. On the negative side, he remarks that the current (and old) inefficiencies will probably continue for quite some time. Also, barring a significant shift in German politics, the fiscal doctrine is not likely to move from austerity to pro-competitive reforms.



Alberto Alesina, Ignazio Angeloni, Federico Etro, 2005. “International Unions”, American Economic Review

Federico Boffa, Amedeo Piolatto & Giacomo A.M. Ponzetto, 2016. “Political Centralization and Government Accountability” Quarterly Journal of Economics

Marcelin Joanis, 2014. Shared Accountability and Partial Decentralization in Local Public Good Provision. Journal of Development Economics

Gino Gancia, Giacomo Ponzetto, Jaume Ventura, 2016. “Globalization and Political Structure”, NBER Working Paper No. 22046

Torsten Persson, Guido Tabellini, 1996. “Federal Fiscal Constitutions: Risk Sharing and Redistribution”, Journal of Political Economy

Bruce Stokes, Euroskepticism Beyond Brexit, Pew Research Center, June 7, 2016

Barcelona GSE Trobada: The Future of Europe Roundtable – Migration (2/3)

Migration in the EU and its economic impacts

By Julian di Giovani

Professor di Giovani continued the roundtable with a presentation on the theme of migration in the EU. He first articulated it around a thorough analysis of the current situation and the data. Even if inflows massively increased in 2015 due to the refugee crisis, migration in the EU is not not new and deals with various inflows coming from outside and inside the EU. Looking at historical data, migration to Europe has been a steady process since WWII and notably accelerated in 2006 after the significant extension of the European Union to ten countries, mostly in Eastern Europe.  Contrary to what is usually expected, the proportion of foreigners in 2014 was similar in the US and in the largest European countries.

Research has been very active in breaking down and understanding the net economic impact of immigration, with an extensive literature on underlying economic variables. The first results from Borjas (1995) highlighted limited gains (to the tune of 0.1% of GDP) and even negative aggregate gains. Borjas found that overall gains were lower than net fiscal costs implying a transfer of wealth from nationals to immigrants. However, Borjas already added place for positive effects when the level of skills of immigrants was taken into account. Recent research has shown larger gains of immigration: Klein and Ventura (2007) through labour reallocation extension in a growth model; di Giovanni, Levchenko and Ortega (2015) in multicountry model that focuses on increased varieties and remittances. Another line of research summarized by Clemens (2011), noted that globalization was most successful in terms of economic gains with the mobility of the labour factor rather than that of capital and goods.


Source: “Economics and Emigration: Trillion-Dollar Bills on the Sidewalk?”, Clemens, M., Journal of Economic Perspectives, 2011

Ortega and Peri (2014) also found positive evidence in a cross-country analysis of income per person and predicted openness to migrants, with results driven by Total Factor Productivity due to diversity effects such as differentiated skills in labour force and increased innovation. Labour market outcomes are also addressed in de la Rica, Glitz and Ortega (2015) with the confirmation that migrants are more unemployed and paid less but also that countries are unequal in education level of their migrant populations. The direct question is then the distributional effects of these labour market outcomes for native workers. The first results are mixed: Borjas (2003) finds that immigration is responsible for large drop in unskilled wages in the US while Ottaviano and Peri (2012) establish the opposite in a model that allows imperfect substitution between immigrants and nationals with equal education and experience. Looking at the firm-level data in Germany, Dustmann and Glitz (2015) show that changes in the skill mix of local labor supply are mostly absorbed by adjustments within firms with changes in relative factor intensities as well as firms entering and exiting the market. Finally, net fiscal effects remain hard to estimate. Contrary to Borjas (1995), Dustmann and Frattini (2014) get a positive and substantial effect when exploiting micro data for the UK over 1995-2001.

Going forward, Professor di Giovanni insisted that migration is indeed a blessing for the European Union’s ageing population and can also facilitate the increase of female participation in the labour market. Innovative policy is of course needed but some solutions already exist, such as the EU Blue Card scheme for high-skills workers, and should be more developed to get results in the short run. But this also requires both institutional and social rigidities to be tackled as well as more resources: an appropriate policy reaction should go far beyond the migration issue only, which cannot be taken as an isolated issue.


George J. Borjas, 1995. “The Economic Benefits from Immigration,” Journal of Economic Perspectives

George J. Borjas, 2003. “The Labor Demand Curve is Downward Sloping: Reexamining the Impact of Immigration on the Labor Market”, Quarterly of Journal Economics

Paul Klein, Gustavo J. Ventura, 2007. “TFP Differences and the Aggregate Effects of Labor Mobility in the Long Run” The B.E. Journal of Macroeconomics

Julian Giovanni & Andrei A. Levchenko & Francesc Ortega, 2015. “A Global View Of Cross-Border Migration,” Journal of the European Economic Association

Michael A. Clemens, 2011. “Economics and Emigration: Trillion-Dollar Bills on the Sidewalk?”, Journal of Economic Perspectives

Francesc Ortega, Giovanni Peri, 2014. “Openness and income: The roles of trade and migration”, Journal of International Economics

Gianmarco I. P. Ottaviano & Giovanni Peri, 2012. “Rethinking The Effect of Immigration On Wages,” Journal of the European Economic Association

Christian Dustmann & Albrecht Glitz, 2015. “How Do Industries and Firms Respond to Changes in Local Labor Supply?”, Journal of Labor Economics

Christian Dustmann & Tommaso Frattini, 2014. “The Fiscal Effects of Immigration to the UK”, Economic Journal

Barcelona GSE Trobada: The Future of Europe Roundtable – Finance (1/3)

A European (dis)Union

“What is going wrong in the European Union these days?” is probably the question that many European voters have been trying to answer in the past few years and all recent events keep pointing at it. First, the recent showdown between Bundesbank President Weidmann and ECB President Draghi on fiscal policy reminded us that even the monetary union, though initiated first to trigger political union, remains a far from smooth cooperation. Second, the theme of (im)migration has been at the very core of the Brexit campaign and added to the overall dissent among European political leaders. This brings us to a last topic of politics at the European level that will be key to deliver solutions.

In such a dense context, the 14th BGSE Economics Trobada 2016 ended up with a very much welcome roundtable focused on “The Future of Europe” and chaired by Professor Jaume Ventura. To help us understand better these various challenges for the EU and its future, Professor Ventura gathered the affiliated Barcelona GSE professors Fernando Broner, Julian di Giovanni and Giacomo Ponzetto.

Breaking the Bank and Bailing out States: Finance in the EU

By Fernando Broner

European Financial Markets

Professor Broner first presented the financial structure of European capital markets, in opposition to that of the United States. Notably, he highlighted that while equity markets play a greater role than banking sector assets in the US, the relation is more than inverted in the EU where banking sector assets are almost six times the size of equity assets.

Equity markets are regulated by the European Securities and Markets Authority (ESMA), founded only recently in 2011. As pointed by Professor Broner, this young regulator still suffers from weak coordination which restrains its action and thus the extension and deepening of European equity markets. Similarly, the International Financial Reporting Standards (IFRS), adopted in 2002 to bring a unified framework and hence foster equity markets, has not been fully enforced. On top of these regulatory inefficiencies, two more reasons also weigh on European equity markets: a strong home bias (64% of EU and 61% of Eurozone equity is held domestically) instead of more interconnections between European countries; as well as the fact that banks mostly lend to each other through debt instruments.

Despite European banks having large activities abroad (18% vs 9% in the US), they are smaller and less diversified, in comparison to their American competitors. However, Professor Broner noted that the crisis prevention framework was today better articulated, under the ECB’s Single Supervisory Mechanism and an improved interaction between the European Commission and the European Banking Authority (EBA) at the rule-making level. The picture is less positive though for crisis management due to responsibilities shared at both the national (lender of last resort, deposit insurance) and European level (Single Resolution Mechanism (SRM) and European Stability Mechanism (ESM)).

Sovereign Debt and Bail Out control

Professor Broner then turned to sovereign debt, another highly sensitive topic for the EU. Prior to the global financial crisis, sovereign risk had almost disappeared in the Euro-area as spreads for all countries were trading in the same range. Part of this decline and convergence in spreads could be explained by expectations of “automatic” bail-outs and a higher cost of default, which proved both inefficient and inaccurate. Along the Eurozone debt crises, various packages were set up to address bail-outs: at the beginning the International Monetary Fund was very active along with European countries and progressively took a step back to let the EU new financial institutions (first the European Financial Stability Facility then the ESM) take over and manage the bail-outs packages. Even the ECB has been directly involved with its Security Markets Programme enacted in 2010 to purchase mostly sovereign bonds. Professor Broner highlighted the unclear role of the ESM: it is similar to a bank capitalized by Eurozone members, whose priority is to provide liquidity. However, it remains criticized by some countries as it offers a kind of transfer scheme, notably through its high maturity loans at very low interest rates. Another challenge is the “sovereign-bank embrace” generated by the current institutional setup, with Eurozone banks holding more and more government bonds. This has serious implications as it crowds out lending to the private sector and reinforces banks’ exposure to sovereign risk while reciprocally banks’ exposure affects also government on the fiscal side as the cost of banking crises significantly participated to the sharp increase of public debt ratios of these countries.


Source: Professor Broner’s presentation

Professor Broner concluded his presentation with some recommendations for the future of European finance. First, remaining barriers to international diversification in the equity markets should be removed. Second, banks’ risk sharing should be improved by encouraging more equity exposure as well as consolidation across countries with more regulation of banks’ subsidiaries. Finally, there should some disincentive action against the current sovereign-bank embrace trend with a direct lender of last resort scheme, direct ESM funding for recapitalizing banks and limitations to the sovereign exposure.