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Inflation risk and the labor market: beneath the surface of a flat Phillips curve

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  • Sirio Aramonte

Abstract

While the Phillips curve appeared quiescent after the Great Financial Crisis (GFC), inflation risk, as gauged from option prices, remained sensitive to employment dynamics. Using Phillips-curve regressions centered on option-implied moments, I show that, in tight labor markets, a fall in the unemployment gap raises the risk that inflation overshoots expectations – even if realized and expected inflation remain stable. In tight labor markets, implied moments convey valuable information, as shown by their ability to anticipate future patterns in inflation breakevens and wage growth. The usefulness of inflation options in assessing risk, despite their illiquidity, is rooted in reputational incentives that dealers have to disseminate accurate quotes.

Suggested Citation

  • Sirio Aramonte, 2022. "Inflation risk and the labor market: beneath the surface of a flat Phillips curve," BIS Working Papers 1054, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:1054
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    References listed on IDEAS

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    More about this item

    Keywords

    inflation expectations; inflation risk; inflation options; labor market;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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