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How likely is an inflation disaster?

Author

Listed:
  • Jens Hilscher

    (University of California, Davis)

  • Alon Raviv

    (Bar-Ilan University)

  • Ricardo Reis

    (London School of Economics)

Abstract

Long-dated inflation swap contracts provide widely-used estimates of expected inflation. We develop methods to estimate complementary tail probabilities for persistently very high or low inflation using inflation options prices. We show that three new adjustments to conventional methods are crucial: inflation, horizon, and risk. An application of these methods finds: (i) US deflation risk in 2011-14 has been overstated, (ii) ECB unconventional policies lowered the deflation disaster probability, (iii) inflation expectations deanchored in 2021-22, (iv) and reanchored as policy tightened, (v) but the 2021-24 disaster left scars, (vi) US expectations are less sensitive to inflation realizations than in the EZ.

Suggested Citation

  • Jens Hilscher & Alon Raviv & Ricardo Reis, 2024. "How likely is an inflation disaster?," Discussion Papers 2437, Centre for Macroeconomics (CFM).
    • Handle: RePEc:cfm:wpaper:2437
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    File URL: https://www.lse.ac.uk/CFM/assets/pdf/CFM-Discussion-Papers-2024/CFMDP2024-37-Paper.pdf
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    More about this item

    Keywords

    option prices; inflation derivatives; Arrow-Debreu securities;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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