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Financial shocks and inflation dynamics

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

No 41/2016, Discussion Papers from Deutsche Bundesbank

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 latest financial crisis. We then explore the transmission channels of financial shocks relevant for inflation, and find that the cost channel can explain 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.

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)
Date: 2016
New Economics Papers: this item is included in nep-cba, nep-fdg, nep-mac and nep-mon
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Related works:
Working Paper: Financial shocks and inflation dynamics (2020) Downloads
Working Paper: Financial shocks and inflation dynamics (2016) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bubdps:412016

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