Perspectives on Aggregate Inflation
Paper Session
Sunday, Jan. 5, 2025 8:00 AM - 10:00 AM (PST)
- Chair: Emily Marshall, Denison University
Central Bank Inflation Forecasts and Firms' Price Setting in Times of High Inflation
Abstract
Using a randomized survey among firms, we study how information about inflation, energy costs, and wage dynamics affects firms’ pricing strategies in a high-inflation environment. Firms exposed to information about central bank inflation forecasts intend to raise prices less than uninformed firms. The effect is more pronounced for firms whose inflation expectations are less aligned with central bank forecasts, those that are less attentive to past inflation dynamics, and those that are more satisfied with overall economic policy. The study highlights the important role of central bank communication in managing inflation, which is particularly crucial during periods of high inflation.Good Inflation, Bad Inflation: Implications for Risky Asset Prices
Abstract
We study the inflation sensitivity of firm-level corporate credit spreads and equity returns, with a particular emphasis on a relatively novel dimension – its time-variation. Using daily inflation swap movements surrounding macroeconomic news releases, we show that in times of market-perceived “good inflation,” when inflation news is positively correlated with real economic growth, shocks to expected inflation substantially reduce corporate credit default swap (CDS) spreads and raise equity valuations. Meanwhile, in times of “bad inflation,” these effects are attenuated and in some instances, also reversed.Following Cieslak and Pflueger (2023), we use the Treasury bond-stock return correlation as a high frequency proxy for the inflation-growth relationship, but our results are robust to other measures. We also find that inflation risk sensitivities are larger for riskier firms and operate mainly through a risk premium channel.
To corroborate our daily findings, we show qualitatively consistent results using high-frequency movements in inflation swaps surrounding macroeconomic announcements. Through a heteroskedasticity approach (e.g., Gürkaynak et al. (2020)) applied to intraday inflation swap data, we display that a latent component unrelated to macroeconomic surprises helps drive the time-varying expected inflation risk in equity and credit pricing.
Our empirical results are consistent with an economic framework where shocks to expected inflation raise discount rates in both good and bad inflation regimes. However, a firm's expected real cash flows display an asymmetric reaction to inflation shocks across regimes. In a good regime, the positive cash flow reaction leads to an increase in equity valuations and, at the same time, a decline in default probabilities of firms with fixed interest rate liabilities. The opposite mechanism holds in bad inflation regimes. Consistent with this cash flow-based intuition, we develop a model with time-varying inflation risk and persistent growth expectations (e.g., Bansal and Yaron (2004)) that rationalizes our empirical findings.
Inflation Surprises and Asset Returns: A Macrohistory Perspective
Abstract
We scrutinize the relationship between inflation and asset returns across 18 advanced countries from 1870 to 2020. To allow for causal inference, we construct a new long-run dataset of inflation surprises - reflecting the unanticipated difference between realized and expected inflation - by exploiting archival and model-derived inflation forecasts. Our analysis unveils a consistent pattern: over the past 150 years, stocks, housing, and bond returns all decline following an inflation surprise. Exploiting the long run data on fixed exchange rate regimes, we point to the pivotal role of monetary policy in shaping the asset price response. When monetary policy does not react, returns on real assets are not affected by inflation surprises.Relative-Price Changes as Aggregate Supply Shocks Revisited: Theory and Evidence
Abstract
We provide theory and evidence that relative price shocks can lead to aggregate inflation consistent with aggregate supply shocks. First, we document that exogenous positive oil price shocks have a positive impact not only on aggregate inflation but also on core inflation, and a negative impact on real activity, consistent with the effects of aggregate supply shocks. We use a multi-sector monetary model with arbitrary input-output linkages and heterogeneity in price stickiness and analytically characterize how sectoral shocks propagate to the aggregate economy and across sectors. We empirically validate our analytical characterization using panel IV local projections, by showing that the responsiveness of sectoral prices to oil price shocks is in line with what is predicted by our analytical expressions. Finally, to highlight the importance of input-output linkages and heterogeneity of price stickiness in the dynamics and persistence of aggregate inflation, we perform an experiment in our model using the aftermath of COVID-19 as a reference to show that even in the absence of aggregate slack, relative price changes can generate persistent aggregate inflation movements.JEL Classifications
- E3 - Prices, Business Fluctuations, and Cycles