Inflation expectation disagreement and monetary policy transmission in a small open economy: Evidence from the Czech Republic

To estimate the impact of disagreement about expected inflation on the transmission of monetary policy in the Czech Republic, this article makes three novel contributions to the literature. First, we reconstruct a series of inflation expectations and calculate their disagreement from qualitative expectations of future price developments back to 2001. We document the limited anchoring of expectations despite consistently low inflation close to or below the inflation target. Second, we infer monetary policy shocks from high-frequency financial data, bringing a novel perspective on the policy of the Czech National Bank. Third, using smooth-transition local projections, we find that when disagreement about future inflation is high, the transmission of unanticipated monetary policy surprises is weakened: inflation and inflation expectations display muted or even counterintuitive (positive) responses to policy tightening. This suggests that in such environments, policy surprises are interpreted less as changes in the stance of policy and more as signals about underlying economic conditions, consistent with the signalling effect of monetary policy highlighted in recent literature. Our findings suggest that unanticipated monetary policy is more effective when disagreement is low, implying that clear communication strategies and, where needed, stronger policy reactions to inflation can play a role in improving transmission. Our results have profound implications for the formulation and implementation of monetary policy in small open economies where central banks in practice consider interest rate differentials vis-à-vis main central banks in their policy decisions.