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Speaker:
Stefano Fasani (Lancaster University)

Nonlinearities with de-anchored inflation expectations

^{(with Mirela Miescu (Lancaster University), Lorenza Rossi (Lancaster University, Univ. of Pavia))}

Abstract: Using a threshold VAR model, we analyze the nonlinear effects of the Federal Reserve's inflation target shocks. The shocks are identified as VAR innovations that make the largest contribution to future movements in long-horizon inflation expectations. Positive shocks trigger an inflationary expansion, while negative shocks lead to recessionary deflation. Importantly, negative shocks have a stronger impact on the output, consumption, investment, and net entry of firms. We rationalize the empirical evidence through a DSGE model embedding heterogeneous firm productivity and firm dynamics. Our findings emphasize the critical role of central bankers in monitoring long-run inflation expectations, particularly during low inflation regimes and when they are de-anchored from below the target, highlighting the importance of maintaining stable long-run inflation expectations to promote economic stability and growth.

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