The Role of Expectations in the Inflation Process in a Period of Exchange Rate Shock

Abstract

In this paper, we analyse the role of inflation expectations in inflation dynamics in periods of rapid and large exchange rate shocks, using evidence from the experience of T & uuml;rkiye during the exchange rate shock in 2018. We employ a time-varying parameter Phillips curve model to focus on the changes in inflation dynamics and jointly study the formation of inflation expectations to investigate further how the setting of inflation expectations evolved. Our results reveal that the interaction between inflation expectations and the exchange rate movements further amplifies their respective impacts on inflation.