Working Paper: NBER ID: w30982
Authors: Anna Cieslak; Carolin Pflueger
Abstract: The past half-century has seen major shifts in inflation expectations, how inflation comoves with the business cycle, and how stocks comove with Treasury bonds. Against this backdrop, we review the economic channels and empirical evidence on how inflation is priced in financial markets. Not all inflation episodes are created equal. Using in a New Keynesian model, we show how “good” inflation can be linked to demand shocks and “bad” inflation to supply shocks driving the economy. We then discuss asset pricing implications of “good” and “bad” inflation. We conclude by providing an outlook for inflation risk premia in the world of newly rising inflation.
Keywords: No keywords provided
JEL Codes: E0; E31; G1; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| good inflation (E31) | increase in stock prices (G10) |
| good inflation (E31) | decrease in risk premium on nominal bonds (E43) |
| demand shocks (E39) | good inflation (E31) |
| bad inflation (E31) | decline in stock prices (G10) |
| bad inflation (E31) | increase in risk premium on nominal bonds (E43) |
| supply shocks (E39) | bad inflation (E31) |
| good inflation (E31) | negative correlation between stock returns and bond yields (G12) |
| bad inflation (E31) | positive correlation between stocks and bonds (G12) |