Functional Shocks to Inflation Expectations and Real Interest Rates and Their Macroeconomic Effects

Journal article


Anderl, C. and Caporale, G. (2023). Functional Shocks to Inflation Expectations and Real Interest Rates and Their Macroeconomic Effects. Review of World Economics.
AuthorsAnderl, C. and Caporale, G.
Abstract

This paper applies a recently developed method (Inoue and Rossi, 2021) to estimate functional inflation expectations and ex-ante real interest rate shocks, and then examines their macroeconomic effects in the context of a Functional Vector Autoregressive model with exogenous variables (Functional VARX). Monthly data from January 1998 to May 2023 for the US, the UK and the euro area are used for the analysis. The estimated impulse responses show significant effects of the functional shocks on both inflation and output. In addition, threshold functional local projections indicate that the effects are nonlinear and depend on central bank credibility. Further, inflation expectations shocks have similar effects to supply (demand) ones when they are driven by long-term (short-term) changes. In the presence of an inverted (steepening) real interest rate term structure, the effects are inflationary (deflationary) and expansionary (recessionary). Finally, the responses of inflation, output and the policy rate are driven primarily by the slope and curvature factors of the term structure shocks, which contain important information not captured by traditional scalar shocks.

KeywordsInflation expectations, term structure, real interest rates, functional shocks
Year2023
JournalReview of World Economics
PublisherSpringer
ISSN1610-2886
Web address (URL)https://link.springer.com/journal/10290
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4583746
Publication dates
Print26 Sep 2023
Publication process dates
Deposited03 May 2024
Accepted author manuscript
License
File Access Level
Open
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