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Inflation Risk

Paper Session

Friday, Jan. 5, 2024 10:15 AM - 12:15 PM (CST)

Grand Hyatt, Bonham B
Hosted By: American Economic Association
  • Chair: Victor Valcarcel, University of Texas-Dallas

Inflation Expectations and Term Premium

Elizaveta Lukmanova
,
KU Leuven
Raf Wouters
,
National Bank of Belgium

Abstract

We study the drivers of the co-movement in inflation expectations and term premium that
we observe in the data. Since these two variables are unobserved, their empirical estimates are
based on different structural models. We build a general equilibrium model that is consistent
with the empirical evidence and incorporates the endogenous dynamics of both variables. To
further account for the fact that these series are unobserved, we introduce information frictions.
We find that the drivers of the co-movement switch from the actions of the Fed to decrease
inflation to shocks originated in financial markets. We interpret this as follows: increased
demand for safe assets drove term premiums down lowering expectations about future growth
and, consequently, about inflation. This switch occurs as the central bank faces challenges in
communicating changes in the target effectively due to the environment of information frictions.

Monetary Policy in the Age of Social Media: A Twitter-Based Inflation Analysis

Nora Lamersdorf
,
Frankfurt School of Finance and Management
Benjamin Born
,
Frankfurt School of Finance and Management
Hrishbh Dalal
,
Frankfurt School of Finance and Management
Sascha Steffen
,
Frankfurt School of Finance and Management

Abstract

We construct an inflation index from German tweets using advanced NLP techniques. Tweets with inflation-related keywords are collected, cleaned using the BERTopic model, and classified as up, down, or neutral using a zero-shot algorithm. The index is strongly correlated with actual inflation and consumer inflation expectations at the national and regional levels and provides improved forecasting accuracy beyond existing measures. Our Twitter-based index can be useful for market participants and policymakers to gauge real-time inflation beliefs.

Sanctions and Russian Online Prices

Jonathan Benchimol
,
Bank of Israel
Luigi Palumbo
,
Bank of Italy

Abstract

Daily data obtained through web scraping allows for the generation of high-frequency signals for evaluating the effects of policies and supporting decision-making processes. The reliability of official price data in Russia has been called into question during the ongoing war in Ukraine. This study investigates the influence of this war and related sanctions on Russian official and online prices for different categories of goods before and after the war. A disaggregated analysis of price patterns finds significant differences in price dynamics following Russia's invasion of Ukraine, which may be attributed to the international economic sanctions that followed. In light of disruptions to traditional channels related to conflicts and political decisions, we contribute to the growing literature using online data to monitor real-time economic activity, price, and quantity evolution. We highlight the importance of political events and economic sanctions on pricing and consumption patterns in times of war, and show that sanctions may have contributed to an average excess CPI level for Russia of 11.7%.

The Price of Macroeconomic Uncertainty: Evidence from Daily Option Expirations

Juan M. Londono
,
Federal Reserve Board
Mehrdad Samadi
,
Federal Reserve Board

Abstract

Using recently available daily S&P 500 index option expirations, we examine the ex ante pricing of uncertainty surrounding key U.S. economic releases and the determinants of risk premia associated with these releases. We first employ an empirical strategy conceptually similar to that of Kelly et al. (2016) which compares option-implied measures for the daily expirations that span U.S. CPI, GDP, FOMC, and Nonfarm Payrolls releases to those of neighboring expirations that do not. Over the weeks preceding a release week, the cost of insurance against price, variance, and downside tail risk is significantly more expensive for option expirations spanning releases. Options spanning releases are not only more expensive, but also more actively traded than neighboring control options.
To examine how the cost of insurance for these releases translates to risk premia, we exploit the expiration grid to construct forward expected return risk premia (Gao and Martin (2021) and Gandhi et al. (2022)) and variance risk premia (Carr and Wu (2009) and Bollerslev et al. (2009)) associated with each economic release. We observe significant time-series variation in the price of risk associated with these releases. We explore the determinants of variations in risk premia across releases, and we find that risk premia are larger during periods of heightened real uncertainty (Jurado et al. (2015)) and monetary policy uncertainty (Baker et al. (2016)). Moreover, risk premia align with the uncertainty expressed in central bank speeches (Gardner et al (2022)) about each type of announcement. The empirical framework presented in this paper can be used to examine the ex ante pricing of a wide variety of events.

Corporate Legacy Debt, Inflation, and the Efficacy of Monetary Policy

Udara Peiris
,
Oberlin College
Charles Goodhart
,
London School of Economics
Dimitrios Tsomocos
,
University of Oxford
Xuan Wang
,
Vrije Universiteit Amsterdam and Tinbergen Institute

Abstract

We show analytically that the presence of an income effect via the stock of corporate debt affects the monetary policy transmission mechanism by weakening its effect on inflation but strengthening its effect on output. Monetary policy becomes less effective in controlling inflation as the stock of corporate debt rises. Above a threshold, the income effect generated by corporate debt causes the final consumption good to become a Giffen Good, whereby lower real wages caused by an increase in the policy rate increases aggregate demand, and raises the price level. This is despite equilibrium output declining because of the higher policy rates. In a calibrated dynamic setting this mechanism exacerbates the trade-off in monetary policy between inflation and output stabilization.
JEL Classifications
  • E3 - Prices, Business Fluctuations, and Cycles