Two Research Analyses

In the last few days, two interesting analyses have been published on inflation dynamics and related topics. Please, find below a short review with a comment for each of them.

NY FED analysis

“The International Experience of Central Bank Asset Purchases and Inflation”

(by G. Benigno and P. Pesenti)

Research question. The authors explore the link between money growth and price stability. Specifically, the authors investigate whether rapid central bank money creation resulting from large-scale purchases of government securities fuel inflationary spending by households and firms.

What the paper does. The authors explore the research question providing circumstantial evidence. Unfortunately, the authors do not carry out any statistical/econometric analysis.

Results. The authors argue that there are many valid reasons to be skeptical about the link between asset purchases and consumer price inflation. According to the authors, the international experience is that the large volume of reserves did not lead to a corresponding increase in broad money. If anything, the evidence points to large declines in the money multipliers. Banks’ lending is not dictated by reserves but by the extent to which commercial banks are willing to extend loans to their customers based on the profitability of those loans, regulatory considerations, and the creditworthiness of the customers. According to the authors, the international experience does not suggest that quantitative easing is necessarily inflationary. Whether these lessons shed light on the post-COVID environment will depend, among other factors, on how the gap between aggregate supply and demand will be closed, and to what extent fiscal policy over the medium term may boost aggregate demand and natural real interest rates, possibly offsetting the high propensity to save by the private sector.

Comment. Interesting analysis on a channel that some economists are revisiting in the aftermath of the Covid-shock. would have expected a more robust statistical analysis, given the names of the authors. Nevertheless, we agree with the conclusion. Going forward, we remain convinced that the interaction between monetary and fiscal policy will be crucial for inflation dynamics.

Cleveland FED paper

“Whose Inflation Expectations Best Predict Inflation?”

(by R. J. Verbrugge and S. Zaman)

Research question. The authors examine the predictive relationship between various measures of inflation expectations and future inflation.

What the paper does.  The authors use cross-correlations, in-sample estimations, and out-of-sample forecasting exercises to assess the relative predictive performance of four measures of inflation expectations: (i) households (Michigan), (ii) professional forecasters (Blue Chip), (iii) firms (Atlanta Fed BIE survey), and (iv) financial markets as captured by the Cleveland Fed model (Haubrich, Pennacchi, and Ritchken (2012)).

Results. The paper finds that expectations of professional economists and of businesses have tended to provide more accurate predictions of future inflation than the expectations of households and of financial market participants.

Comment. Interesting exercise, not particularly sophisticated but nevertheless well executed. Unfortunately, the analysis is run only in CPI space, and only one 1-year ahead measures (short-term expectations). In other words, the relative performance of long-term inflation expectations (which is more relevant for the Fed) is not part of the paper. Nevertheless, taken at face value, the authors’ results are somehow reassuring for future inflation dynamics because the year-ahead business inflation expectations have flattened recently. Not only, but the long-term inflation expectations from the same survey remain very stable (see Figure below).