Financial shocks and inflation dynamics

Angela Abbate (), Sandra Eickmeier and Esteban Prieto ()

No 2020-13, Working Papers from Swiss National Bank

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 Bayesian vector autoregressive model to US data and identify financial shocks through a combination of narrative and short-run sign restrictions. Our main finding is that contractionary financial shocks temporarily increase inflation. This result withstands a large battery of robustness checks. Negative financial shocks help therefore to explain why inflation did not drop more sharply in the aftermath of the financial crisis. Our analysis suggests that higher borrowing costs after negative financial shocks can account for the modest decrease in inflation after the financial crisis. A policy implication is that financial shocks act as supply-type shocks, moving output and inflation in opposite directions, thereby worsening the trade-off for a central bank with a dual mandate.

Keywords: Financial shocks; inflation dynamics; monetary policy; financial frictions; cost channel; sign restrictions (search for similar items in EconPapers)
JEL-codes: E31 E44 E58 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2020
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (3)

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Working Paper: Financial shocks and inflation dynamics (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:snb:snbwpa:2020-13

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