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New Evidence on Inflation Dynamics

Paper Session

Sunday, Jan. 5, 2025 1:00 PM - 3:00 PM (PST)

San Francisco Marriott Marquis, Foothill B
Hosted By: Society for Economic Dynamics
  • Chair: Jonathon Hazell, London School of Economics

Do Deficits Cause Inflation? A High Frequency Narrative Approach

Jonathon Hazell
,
London School of Economics
Stephan Hobler
,
London School of Economics

Abstract

Do fiscal deficits cause inflation? We study high frequency movements in inflation expectations around the 2021 Georgia Senate election runoffs—which, according to narrative evidence, raised expected deficits. Using event studies and instrumental variables, we estimate that Democrat victory caused the market’s expected price level over ten years to increase by 0.76%. Our estimate suggests that overall, higher deficits in late 2020 and early 2021 increased the price level by 7.1%. Turning to mechanisms, nominal interest rates did not change at short horizons but rose at long horizons. We calibrate a three-equation New Keynesian model with bonds-in-utility to standard parameters, including the pre-2020 slope of the Phillips Curve. Feeding in the fiscal shock and the estimated response of interest rates, the model quantitatively accounts for the size and dynamics of expected inflation after Georgia—suggesting an important determinant of inflation has been the combination of loose fiscal and monetary policy.

Inflation Expectations and Corporate Borrowing Decisions: New Causal Evidence

Olivier Coibion
,
University of Texas-Austin
Yuriy Gorodnichenko
,
University of California-Berkeley
Tiziano Ropele
,
Bank of Italy

Abstract

We match survey data of Italian firms that includes a repeated experiment in which information about inflation is randomly provided to firms over time with detailed credit data that covers the borrowing decisions of firms. This allows us to study how exogenous variation in inflation expectations causally affects the borrowing decisions of Italian firms. We document a number of new results. Firms with exogenously higher inflation expectations end up paying higher interest rates on average but do not change the overall demand of loans. Instead, we find a significant rebalancing of firms’ borrowing decisions away from lower-interest long-term loans and toward higher-interest short-term loans. In anticipation of rising future interest rates linked to higher expected inflation, firms also take on new long-term loans to pay down existing loans, thereby locking in interest rate savings. Firms that are relatively more knowledgeable about financial tools engage in the latter particularly strongly.

Housing Demand and Remote Work

John Mondragon
,
Federal Reserve Bank of San Francisco
Johannes Wieland
,
University of California-San Diego

Abstract

We show that the shift to remote work explains over one half of the record 23.8 percent national house price increase from 2019 to 2021. Using variation in remote work exposure across U.S. metropolitan areas, we estimate that an additional percentage point of remote work causes a 0.98 percent increase in house prices after controlling for negative spillovers from migration. This finding reflects an aggregate increase in demand for home space: remote work causes a similar increase in residential rents, a decline in commercial rents, a greater increase in prices for larger homes, and a decline in household size among movers. The cross-sectional effect on house prices combined with the aggregate shift to remote work implies that remote work raised aggregate U.S. house prices by 16.0 percent. Using a model of remote work and location choice, we argue that this estimate is a lower bound on the aggregate effect. Our results argue for a fundamentals-based explanation for the recent increases in housing costs over speculation or financial factors, and that the evolution of remote work is likely to have large effects on the future path of house prices and inflation.

Can U.S. Treasury Markets Add and Subtract?

Roberto Gómez-Cram
,
New York University-Stern
Howard Kung
,
London Business School
Hanno Lustig
,
Stanford University

Abstract

The CBO cost releases of U.S. spending and tax proposals contain valuable news about future primary surpluses priced in by U.S. Treasury investors. Using daily event windows, we find that cost releases with large negative cash flow projections have lowered the valuation of all outstanding Treasurys by more than 20% between 1997 and 2022. The valuation effects are concentrated at longer maturities, with an overall increase of 4% in long-term nominal yields driven by an increase in nominal term premia and inflation expectations and a decrease in convenience yields. We account for these valuation effects in a model with Bayesian bond investors who use the cost releases to learn about the long-run dynamics of U.S. deficits. Using the estimated model, we infer that 57 cents of every dollar in the fiscal expansion is unbacked and passed through to Treasury valuations. Our estimates imply that a one percentage point surprise increase in the expected supply of Treasurys, expressed as a fraction of GDP, corresponds to an increase of the 10-year nominal yield by 31 bps and a drop in the convenience yield of 7.5 bps.
JEL Classifications
  • E0 - General
  • G1 - General Financial Markets