Surveys reveal inflation and growth tail risks, stagflation reemerges
A Banque de France working paper evaluates inflation and growth risks using probabilistic responses from professional forecasters' surveys. The study finds that post-pandemic inflation is driven by temporary adverse supply and persistent positive demand factors, with stagflation risks reemerging in 2022.
Unpacking inflation and growth drivers with surveys
The Banque de France working paper utilizes a dynamic factor model with time-varying uncertainty and asymmetry to analyze the joint dynamics of inflation and growth.
This model decomposes macroeconomic fluctuations into demand and supply components, leveraging probabilistic responses from professional forecasters' surveys.
The use of forward-looking survey data is crucial as it captures macroeconomic risk perceptions and tail-risk expectations, providing information beyond realized inflation and GDP growth.
Demand factors are identified as those driving inflation and real activity in the same direction, while supply factors cause movements in opposite directions.
The model, estimated on US data from 1981-2024, effectively fits realized inflation and growth, as well as the conditional moments of forecast distributions, performing well across various economic conditions including the 1980s, the Great Recession, and COVID-19.
Post-pandemic drivers and stagflation's return
The study finds that post-pandemic inflation is primarily driven by temporary adverse supply factors and more persistent positive demand factors, consistent with supply chain disruptions and large economic stimulus packages in the United States.
Tail risk was prominent in US data during the 1980s and the Great Recession for inflation, and after COVID-19 for GDP growth.
The model-implied correlation between inflation and growth is time-varying, negatively related to nominal term premiums, and on average positive, suggesting professional forecasters do not hold stagflationary beliefs.
However, in 2022, the probabilities of stagflation risk, defined as inflation above 4% and GDP growth below 0%, increased significantly after three decades of near-zero probabilities, marking a notable reemergence of this risk.
Stagflation: A forgotten risk returns
This research offers a crucial, forward-looking lens on inflation and growth risks, moving beyond historical data.
The reemergence of stagflation risks in 2022, after decades of dormancy, provides a critical warning for central banks.
While valuable, the model's reliance on forecaster perceptions means its policy impact depends on alignment with future economic realities.