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How likely is an inflation disaster?

Author

Listed:
  • Hilscher, Jens
  • Raviv, Alon
  • Reis, Ricardo

Abstract

Long-dated inflation swap contracts provide widely used estimates of expected inflation. We develop methods to estimate complementary tail probabilities for persistently very high or low inflation using inflation options prices. We show that three new adjustments to conventional methods are crucial: inflation, horizon, and risk. We find that: (a) U.S. deflation risk in 2011–2014 has been overstated, (b) ECB unconventional policies lowered deflation disaster probabilities, (c) inflation expectations deanchored in 2021–2022, (d) reanchored as policy tightened, (e) but the 2021–2024 disaster left scars, and (f) U.S. expectations are less sensitive to inflation realizations than in the eurozone.

Suggested Citation

  • Hilscher, Jens & Raviv, Alon & Reis, Ricardo, 2025. "How likely is an inflation disaster?," LSE Research Online Documents on Economics 127063, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:127063
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    File URL: http://eprints.lse.ac.uk/127063/
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    Keywords

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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
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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