Inflation: Drivers and Dynamics 2020 Conference Summary

To provide insights into the processes that drive inflationary dynamics, the Federal Reserve Bank of Cleveland holds an annual conference on the topic of inflation: the Inflation: Drivers and Dynamics series. The 2020 installment of the conference was held on May 21-22, 2020. This Commentary summarizes the papers at the conference, which broadly fell into four categories: (1) empirical Phillips curves, (2) networks and Phillips curves, (3) expectations formation, and (4) price-setting behavior and inflation.

Sovereign credit news and disagreement in expectations about the exchange rate: evidence from Brazil

PurposeCredit rating agencies (CRAs) are perceived as highly influential in the financial system since their announcements can affect several players in the financial markets, from big private financial and non-financial companies and their financial markets experts to sovereign states. In this sense, this study investigates whether sovereign credit news issued by CRAs (measured by comprehensive credit rating (CCR) variables) affect the uncertainties about the exchange rate in the future (captured by the disagreement about exchange rate expectations). The study is relevant once there is evidence indicating that CRAs' assessments are responsible for affecting international capital flows and, thus, sovereign rating changes can affect the expectations formation process regarding the exchange rate. In addition, there is evidence indicating that the disagreement about exchange rate expectations affects the disagreement about inflation expectations, which brings consequences to policymakers.Design/methodology/approachThe dependent variables are the disagreement in expectations about the Brazilian exchange rate for different forecast horizons, 12, 24 and 36 months ahead and the first principal component of theses series. On the other hand, the CCR variables are built upon the long-term foreign-currency Brazilian bonds ratings, outlooks and credit watches provided by the main CRAs. Estimates are obtained using ordinary least squares (OLS) and generalized method of moments (GMM); a dynamic analysis is performed using vector-autoregressive (VAR) through impulse-response functions.FindingsNegative (positive) sovereign credit news, given by a rating downgrade (upgrade) and/or a negative (positive) outlook/watch status, increase (decrease) the disagreement about exchange rate expectations. This result holds for all disagreement and CCR variables.Practical implicationsThe study brings practical implications to both private agents (mainly financial market experts) and policymakers. An important practical implication of the study concerns the ability of CRAs to affect the expectations formation process of financial market experts regarding the future behavior of the exchange rate. When a CRA issues a signal of improvement in a country's sovereign rating, this signal reflects the perception of improvement in macroeconomic fundamentals and reduction of uncertainties about the country's ability to honor its financial obligations, which therefore, facilitates the expectations formation process, causing a reduction in the disagreement about the exchange rate expectations. With respect to the consequences for policymakers, they will have more difficulty in guiding expectations in a country with a worse sovereign risk rating, where agents have difficulties in forming expectations and the disagreement in expectations is greater.Originality/valueThe study is the first to analyze the impact of CRAs' announcements on the disagreement about exchange rate expectations. Moreover, it connects the literature that investigates the effects of sovereign credit news on the economy with the literature that examines the main determinants of disagreement in expectations about macroeconomic variables.

Dynamic Linkages and Volatility Transmissions between Macroeconomic Uncertainty and Performance: Evidence from South Asian Countries

In this article, we examine the time-varying linkages and volatility transmissions between macroeconomic uncertainty and macroeconomic performance in four South Asian countries over the last 20–30 years. Through the lens of bivariate GARCH family models supplemented with two-step procedure, we arrive at several important conclusions. First, there is an overwhelming support for the Friedman–Ball hypothesis that higher inflation leads to inflation uncertainty in all countries. Second, Holland’s idea of negative influence of inflation volatility on the level of inflation holds only for one country (India). Third, there is no significant effect of macroeconomic uncertainty on the output growth in all countries under study, where real uncertainty induces inflation but impedes output growth, except in India. Fourth, output growth leads to decline real uncertainty in all countries except Sri Lanka and improves (reduces) inflation uncertainty in India (Bangladesh) only. Fifth, there is a statistically significant bidirectional causality between real and nominal uncertainties for at least half of the countries. Finally, there is an adverse effect of higher inflation on the output growth for Pakistan. We suggest that policymakers in these countries should pay more attention to expectations formation and should adopt dynamic monetary stabilization and inflation-targeting strategies, coupled with sustainable growth measures, for reducing macroeconomic volatilities.