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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 a New Keynesian model, we show how “good” inflation can be linked to demand shocks and “bad” inflation to cost-push 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.
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Business-Cycle Anatomy
We propose a new strategy for dissecting the macroeconomic time series, provide a template for the business-cycle propagation mechanism that best describes the data, and use its properties to appraise models of both the parsimonious and the medium-scale variety. Our findings support the existence of a main business-cycle driver but rule out the following candidates for this role: technology or other shocks that map to TFP movements; news about future productivity; and inflationary demand shocks of the textbook type. Models aimed at accommodating demand-driven cycles without a strict reliance on nominal rigidity appear promising. (JEL C22, E10, E32)
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- Award ID(s):
- 1757198
- PAR ID:
- 10251300
- Date Published:
- Journal Name:
- American Economic Review
- Volume:
- 110
- Issue:
- 10
- ISSN:
- 0002-8282
- Page Range / eLocation ID:
- 3030 to 3070
- Format(s):
- Medium: X
- Sponsoring Org:
- National Science Foundation
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- Free Publicly Accessible Full Text
-
Accepted Manuscript1.0
- Journal Article:
- https://doi.org/10.1257/aer.20181174
