Periodic Reporting for period 4 - INFL (New perspectives on inflation)
Periodo di rendicontazione: 2021-01-01 al 2021-06-30
The research in this project aims to deepen our understanding of inflation by exploring the interaction between what central banks do, how people form expectations, and how both of these interact with financial markets and with the resource flows that come with them. The last twenty years in Europe (as well as the UK and the US) have seen inflation lower and more stable than ever before in recorded history. At the same time, three concerns have emerged. First, before the pandemic there was increasing concern that central banks had lost their ability to raise inflation, and especially that inflation expectations in financial markets have anchored at too low a level. In 2021-22 these concerns led to fears that inflation expectations had become unanchored, and that the central bank was powerless to stop the rise in inflation because of the self-fulfilling nature of these expectations. Second, with a large and growing public debt, and central banks that have large balance sheets with many government bonds in their assets, there is a realization of a growing tension between the actions of the central bank and their fiscal implications for the ministers of finance. Moreover, after the pandemic, the sharp rise in public debt coming hand in hand with the inflation of 2021-22 led to a reinvestigation of the old possibility of inflating away he public debt. Third, with the undertaking of many unconventional policies by central banks in response to the financial crises, choices must be made on which of these policies to keep in normal times or not.
This research answers these questions. It uses insights from finance and economic history, together with new methods, and unconventional approaches on the solvency of a central bank or the use of monetary policy tools, to understand what determines actual and expected inflation. It uses new data, and introduces new models, that can provide a deeper understanding of the dynamics of inflation. All of the questions above were answers making some progress in deepening our knowledge of inflation and of the interaction between central banks and financial markets. The importance of this is especially clear today, in 2022, as inflation looms large as one of the main problems according to surveys in many European countries.
This research answers these questions. It uses insights from finance and economic history, together with new methods, and unconventional approaches on the solvency of a central bank or the use of monetary policy tools, to understand what determines actual and expected inflation. It uses new data, and introduces new models, that can provide a deeper understanding of the dynamics of inflation. All of the questions above were answers making some progress in deepening our knowledge of inflation and of the interaction between central banks and financial markets. The importance of this is especially clear today, in 2022, as inflation looms large as one of the main problems according to surveys in many European countries.
As part of this project, 14 scientific articles were produced as well as one book. Of these, 7 are already published, and another 7 are at different stages in revisions and resubmission. More than 31 keynote lectures were given disseminating the work, and 11 students have been employed part time in the activities of the research, together with 3 full time. Three significant prizes were awarded to the PI, the prize for best economics researchers working in Europe under the age of 45, the prize for best macroeconomist under the age of 40 with European nationality, and the prize for best researcher working macroeconomics or finance under the age of 40 that is based in Europe.
Scientifically, the main results are:
-- central banks can and go insolvent, whenever they are independent and do not have full fiscal backing.
-- the central force through which the central bank controls inflation in modern monetary models is arbitrage in financial markets, not the price setting of firms
-- different theories of inflation correspond to different monetary policy strategies, all consistent within the same framework
-- the Euro still struggles with the divergent inflation rates within the region, and the lack of a common safe asset
-- because inflation is sluggish and the maturity of the public debt held by the public is relatively low, the ability to inflate away the debt is quite limited
-- macro prudential policy has important fill interactions, and it can be captures by fiscal policy dominance
-- what has sustained the large increase in the public debt in the last twenty years is the growing gap between the private returns to capital and the return form holding public debt
-- concerns for business cycle stabilization call for more generous unemployment insurance, but not more progressive taxes.
-- data on inflation expectations from surveys and from asset prices can be combined to uncover an estimate of the fundamental expectation of inflation behind them
-- the US inflation anchor was lost in the second half of the 1960s, and this could have been detected using survey data
-- one can use inflaton options to extract the probability of an inflation disaster at a far horizon.
-- the liquidity lines between central banks are a form of lender of last resort creating an international financial architecture
-- jumpstarting a currency to be widely used outside of a country's borders requires some decisive policies
-- the literature on macro and financial determinants of crashes is sufficiently mature that it can be translated to a general audience.
Scientifically, the main results are:
-- central banks can and go insolvent, whenever they are independent and do not have full fiscal backing.
-- the central force through which the central bank controls inflation in modern monetary models is arbitrage in financial markets, not the price setting of firms
-- different theories of inflation correspond to different monetary policy strategies, all consistent within the same framework
-- the Euro still struggles with the divergent inflation rates within the region, and the lack of a common safe asset
-- because inflation is sluggish and the maturity of the public debt held by the public is relatively low, the ability to inflate away the debt is quite limited
-- macro prudential policy has important fill interactions, and it can be captures by fiscal policy dominance
-- what has sustained the large increase in the public debt in the last twenty years is the growing gap between the private returns to capital and the return form holding public debt
-- concerns for business cycle stabilization call for more generous unemployment insurance, but not more progressive taxes.
-- data on inflation expectations from surveys and from asset prices can be combined to uncover an estimate of the fundamental expectation of inflation behind them
-- the US inflation anchor was lost in the second half of the 1960s, and this could have been detected using survey data
-- one can use inflaton options to extract the probability of an inflation disaster at a far horizon.
-- the liquidity lines between central banks are a form of lender of last resort creating an international financial architecture
-- jumpstarting a currency to be widely used outside of a country's borders requires some decisive policies
-- the literature on macro and financial determinants of crashes is sufficiently mature that it can be translated to a general audience.
New methods have been introduced to measure expected inflation and its persistence, to assess the solvency of the central bank, to measure the fiscal footprint of central bank actions, to combine financial analysis with economic history to understand the intervention of central banks in debt markets, to measure the sensitivity of the public debt to inflation. These all pushed the state of the art in the study of inflation.
Until the end of the project, I will be pursuing the interaction between market and survey inflation expectations, the fiscal footprint of macroprudential tools, and the development of a risk management framework for central banks. Moreover it wants to study central bank swap lines, to make the link form the swap lines to the more general lender of last resort, and how to use the changes in the rates charged for them, or the details on how auctions were opened and ran, to identify their effects.
The goal of this research program was to provide a new perspective on inflation as determined and determining financial values. This required developing new methods to combine information coming from surveys and market prices on inflation, and to understand how monetary policy interacts with financial markets. All were completed by the end.
Until the end of the project, I will be pursuing the interaction between market and survey inflation expectations, the fiscal footprint of macroprudential tools, and the development of a risk management framework for central banks. Moreover it wants to study central bank swap lines, to make the link form the swap lines to the more general lender of last resort, and how to use the changes in the rates charged for them, or the details on how auctions were opened and ran, to identify their effects.
The goal of this research program was to provide a new perspective on inflation as determined and determining financial values. This required developing new methods to combine information coming from surveys and market prices on inflation, and to understand how monetary policy interacts with financial markets. All were completed by the end.