Template-type: ReDIF-Paper 1.0
Author-Name: Dr. Angela Abbate
Author-Name-First: Angela
Author-Name-Last: Abbate
Author-Person: pab300
Author-Name: Sandra Eickmeier
Author-Name-First: Sandra
Author-Name-Last: Eickmeier
Author-Person: pei21
Author-Name: Esteban Prieto
Author-Name-First: Esteban
Author-Name-Last: Prieto
Author-Person: ppr221
Title: Financial shocks and inflation dynamics
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.
Length: 49 pages
Creation-Date: 2020
Contact-Email: forschung@snb.ch
File-URL: https://www.snb.ch/en/publications/research/working-papers/2020/working_paper_2020_13
File-Format: text/html
Number: 2020-13
Classification-JEL: E31, E44, E58
Keywords: Financial shocks, inflation dynamics, monetary policy, financial frictions, cost channel, sign restrictions
Handle: RePEc:snb:snbwpa:2020-13