Macroeconomic Drivers and the Pricing of Uncertainty, Inflation, and Bonds

Brandyn Bok, Thomas Mertens and John Williams

No 1011, Staff Reports from Federal Reserve Bank of New York

Abstract: The correlation between uncertainty shocks, as measured by changes in the VIX, and changes in breakeven inflation rates declined and turned negative after the Great Recession. This estimated time-varying correlation is shown to be consistent with the predictions of a standard New Keynesian model with a lower bound on interest rates and a trend decline in the natural rate of interest. In one equilibrium of the model, higher uncertainty raises the probability of large shocks that leave the central bank constrained by the lower bound and unable to offset negative shocks. Resulting inflation shortfalls lower average inflation rates.

Keywords: interest; uncertainty; inflation; equilibrium; lower bound; shocks; liquidity (search for similar items in EconPapers)
JEL-codes: E52 G12 (search for similar items in EconPapers)
Pages: 66
Date: 2022-04-01
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
Note: Revised April 2025.
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Working Paper: Macroeconomic Drivers and the Pricing of Uncertainty, Inflation, and Bonds (2022)
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