Ricardo Reis, LSE

4to piso y a través de Zoom

“How likely is an inflation disaster?”

The prices of long-dated inflation swap contracts provide a much-used measure of expected inflation at far horizons. This paper develops the methods to estimate complementary tail probabilities for persistently very high or very low inflation using the prices of inflation options. For the object of interest—inflation, disasters, at long horizons—three adjustments to conventional measures are crucial, for real payoffs, risk, and horizon. Applying the method to the US and the Eurozone (EZ) we find that (i) the probability of US deflation in 2011-14 was not so high, (ii) the tail probability of a deflation trap in the EZ post 2015 has been high throughout in spite of varying policies and shocks, and (iii) there was a significant rise in 2021 in the risk of persistent high US inflation