Do Inflation Expectations Become More Anchored during a Disinflation Episode? Evidence for Euro Area Firms

Post-COVID-19 adjustments, the Russian full-scale invasion of Ukraine, and other factors led to a dramatic surge in inflation in the euro area. The European Central Bank's (ECB's) tight monetary policy contributed to a steep disinflation trajectory: Inflation fell from 10.6 percent in October 2022 to 2.2 percent in November 2024. However, since experiences of high inflation could have a scarring effect (Malmendier and Nagel 2016), it remains to be seen how the inflation cycle has affected the anchoring of inflation expectations. This issue is of first-order importance because "fluid" expec-tations can amplify future inflationary shocks and thus can result in another inflation spike, which would undermine the credibility of the central bank. To shed more light on the matter, we examine the evolution of firms' inflation expectations in the euro area during the recent disinflation episode. We document clear progress in bringing inflation expectations toward the target, but this process has not been completed yet, and thus policymakers should proceed with caution.