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Financial Shocks and Inflation Dynamics

Author

Listed:
  • Angela Abbate
  • Sandra Eickmeier
  • Esteban Prieto

Abstract

We assess the effects of financial shocks on inflation, and to what extent financial shocks can account for the "missing disinflation" during the Great Recession. We apply a vector autoregressive model to US data and identify financial shocks through sign restrictions. Our main finding is that expansionary financial shocks temporarily lower inflation. This result withstands a large battery of robustness checks. Moreover, negative financial shocks helped preventing a deflation during the crisis. We then explore the transmission channels of financial shocks relevant for inflation, and find that the cost channel explains the inflation response. A policy implication is that financial shocks that move output and inflation in opposite directions may worsen the trade-off for a central bank with a dual mandate.

Suggested Citation

  • Angela Abbate & Sandra Eickmeier & Esteban Prieto, 2016. "Financial Shocks and Inflation Dynamics," CAMA Working Papers 2016-53, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    • Handle: RePEc:een:camaaa:2016-53
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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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