policymakers demonstrate

Fiscal and Monetary Policies after the Crises 441
zero bound, causing negative supply shocks to be expansionary, so long as the
zero bound episode is expected to last sufficiently long.
The paper then asks whether there is empirical support for this paradoxical
outcome. This is of interest beyond the positive question of how best to analyse
supply shocks, because the dynamics that cause supply shocks to be expansionary
in theory are identical to those that imply structural reform could be
contractionary in Europe. Indeed, they constitute the central mechanism in the
New Keynesian literature on policy at the zero bound: the interaction between
expected future inflation on current aggregate demand. The results of Wieland’s
study sound a cautionary note. In a first exercise he extracts a data series of
international oil price shocks, and shows that these shocks do indeed generate
increases in expected inflation, but are nonetheless associated with short-run
increases in unemployment and reductions in production – contrary to the prediction
that economic activity should expand. A second part of the analysis
draws similar conclusions from the economic developments that followed the
Japanese earthquake in 2011.
These results certainly present challenges for the New Keynesian framework,
though there are different ways to read them. The analysis is complicated by the
presence of two simultaneous economic shocks. First, there is a shock to desired
savings, which takes the form of a higher value for β t in Equation (10.4). Second,
there is a shock to productive capacity. The overall outcome will depend
on whether the income effect of lower capacity dominates the effect due to
expected inflation increasing. As Wieland (2014) shows, this hinges on which
of the two shocks will have a longer duration. The supply shock is only guaranteed
to be expansionary if its duration is known to be shorter than the shock to
desired savings. More generally, the theoretical predictions can go either way.
Wieland’s data have not falsified the inflation expectations channel per se – just
the contention that this channel ought to dominate the effects of oil price shocks
and earthquakes on the macroeconomy.
Complementary to this work is the paper by Bachmann et al. (2015). These
authors use US micro data to examine the link between expected inflation and
consumers’ willingness to spend on durable goods. During ‘normal’ times,
when the zero bound does not bind, they find no significant relationship –
though this can easily be explained by the fact that monetary policy responds
endogenously to higher inflation, preventing the real interest rate from being
significantly affected. More worryingly for the theoretical literature, the data
do point to a significant negative effect of inflation expectations on durables
spending when interest rates are constrained at zero. This is the opposite of
what theory would predict, as lower future inflation should lower the relative
benefits to holding cash.
Ongoing work by Bahaj and Rendahl (2015) partially reinforces these
conclusions. Using data from the US Survey of Professional Forecasters,
these authors study the role of inflation expectations in the macroeconomic