Probability of extreme inflation realizations
In this paper, Hilscher et al. develop a new method to translate the prices of traded inflation derivatives into risk-neutral and physical measure probabilities of inflation. They then apply this method to data from the US and the Eurozone between 2010 and November of 2021. Their findings include:
- For the Eurozone, the risk of a deflation trap since 2015 persisted throughout and continues to be present, in spite of different waves of ECB policy that tried to eliminate it. It was present also during the pandemic;
- For the US, there is a steady, significant and accelerating rise in the probability of persistent high inflation. It was well above 10% by the second half of 2021, and approached 20% by the end of the year.
[P]robabilities of inflation disasters are informative about macroeconomic risk, monetary policy regimes, and the credibility of the central bank. Under an inflation targeting regime, at these forward distant horizons, the success of a central bank at anchoring expectations near the target can partly be measured by whether the disaster probabilities are small.
How likely is an inflation disaster?
Authors: Jens Hilscher, Alon Raviv, Ricardo Reis
From: UC Davis, Bar-Ilan University, LSE
Why the current US inflation is worrisome
In this commentary, Olivier Blanchard asks whether the Fed can now engineer a soft landing with its anticipated monetary tightening. The comparison with the 1970s is eerie, he argues:
- In early 1975, core inflation was running at 12 percent and the real policy rate was equal to about −6 percent, a gap of about 17 percent;
- Today, core inflation is running at 6 percent and the real policy rate is equal to −6 percent, a gap of 12 percent—smaller than in 1975 but significantly large nevertheless.
He concludes that the current situation is worrisome because the current spike in US inflation is most likely not temporary:
When movements in prices are limited, when nominal wages rarely lag substantially behind prices, people may not focus on catching up and may not take variations in inflation into account. But when inflation is suddenly much higher, both issues become salient, and workers and firms start paying attention and caring. I find the notion that workers will want to be compensated for the loss of real wages last year, and may be able to obtain such wage increases in a very tight labor market, highly plausible, and I read some of the movement in wages as reflecting such catchup.
Why I worry about inflation, interest rates, and unemployment
By: Olivier Blanchard – Peterson Institute
