Inflation risk and the labor market: beneath the surface of a flat Phillips curve

Sirio Aramonte

No 1054, BIS Working Papers from Bank for International Settlements

Abstract: While the Phillips curve appeared quiescent after the Great Financial Crisis (GFC), inflation risk, as gauged from option prices, remained sensitive to employment dynamics. Using Phillips-curve regressions centered on option-implied moments, I show that, in tight labor markets, a fall in the unemployment gap raises the risk that inflation overshoots expectations – even if realized and expected inflation remain stable. In tight labor markets, implied moments convey valuable information, as shown by their ability to anticipate future patterns in inflation breakevens and wage growth. The usefulness of inflation options in assessing risk, despite their illiquidity, is rooted in reputational incentives that dealers have to disseminate accurate quotes.

Keywords: inflation expectations; inflation risk; inflation options; labor market (search for similar items in EconPapers)
JEL-codes: G12 G14 G23 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2022-11
New Economics Papers: this item is included in nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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