Viral V. Acharya is the C.V. Starr Professor of Economics in the Department of Finance at New York University Stern School of Business (NYU-Stern) .Detailed profile can be found HERE.
December 20, 2024
Measuring Inflation Uncertainty
Inflation uncertainty plays a crucial role in the management of inflation-output tradeoff by a central bank, understanding of macroeconomic uncertainty, modelling of interest rate volatility and term premia in fixed income markets, and consumption-investment decisions. However, reliable empirical measures of inflation uncertainty are no longer directly available for the United States(US) due to a lack of trading in inflation-linked options since the end of 2017. We fill this gap by providing two sets of real-time measures of inflation uncertainty. The first set is based on textual analysis of news articles performed using a Large Language Model over the period from 1950 to August 2024. The second set combines market-based information, viz., commodity option prices and realized as well as expected inflation, over the period from 2005 to2023, trained using a machine-learning algorithm to match two measures of implied inflation volatility extracted from: (i) options on exchange-traded funds (ETFs) holding real and nominal US Treasuries over the period 2011 to2023, and (ii) inflation-linked options over the period from 2011 to 2017. We compare our measures to other economic uncertainty measures and find some overlapping but also much independent information across the measures. In terms of applications, we first study narratively and textually the drivers of inflation uncertainty over time, secondly show the ability of our measures to explain low-frequency inflation uncertainty measures gathered in surveys of professional forecasters and consumer expectations, and finally, document structural shifts in the evolution of interest-rate uncertainty relative to inflation uncertainty, especially in the post-COVID era.
Inflation expectations, inflation swaps, Large Language Models, machine learning, interest rate options, ETF options, caps and floors.
