Assessing Shocks to Inflation Expectations in a Data Rich Environment

We carry out a semi-structural analysis aiming at estimating the macroeconomic effects of shocks to inflation expectations. We estimate a Structural Factor Model for the euro area, which includes more than 200 quarterly variables. By using such a wide information set we are able to: 1) identify structural shocks which a small-scale VAR would not be able to retrieve; 2) avoid any variable selection bias; 3) exploit as many variables as we need to identify the shocks, and study their responses in a unified framework. We find that the euro area economy can be well described by four structural shocks, and assume that one of these shocks has an expectational nature. To achieve identification of this shock, we use a mix of zero and sign restrictions. Our results confirm an important role for inflation expectations in affecting the dynamics of real and nominal variables.