Inflation Dynamics of Financial Shocks

TL;DR

This paper investigates how different financial shocks influence US inflation using a Bayesian SVAR model that identifies shocks through data non-normalities and inequality constraints, revealing two distinct shocks with opposing effects.

Contribution

It introduces a novel Bayesian SVAR approach that exploits data non-normalities and inequality constraints to identify and differentiate financial shocks affecting inflation.

Findings

Two distinct financial shocks with opposing effects on inflation

Financial shocks influence the economy via demand and supply channels

Methodology effectively isolates and characterizes different shocks

Abstract

We study the effects of financial shocks on the United States economy by using a Bayesian structural vector autoregressive (SVAR) model that exploits the non-normalities in the data. We use this method to uniquely identify the model and employ inequality constraints to single out financial shocks. The results point to the existence of two distinct financial shocks that have opposing effects on inflation, which supports the idea that financial shocks are transmitted to the real economy through both demand and supply side channels.