The Signalling Content of Asset Prices for Inflation: Implications for Quantitative Easing

Abstract

We investigate the information content of financial variables as signalling devices of two abnormal inflationary regimes:

(1) very low inflation or deflation, and

(2) high inflation.

Specifically, we determine the information content of equity and house prices, private credit volumes, and sovereign and corporate bond yields, for 11 advanced economies over the past three decades, using both the receiver operating characteristic (ROC) curve and a logit model. The outcomes show that high asset prices more often signal high inflation than low inflation/deflation. However, in some countries, high asset prices and low bond yields are a significant indicator of low inflation or deflation as well. The transmission time of financial developments to inflation can be quite long (up to 8 quarters). For monetary policy, these findings imply that stimulating asset prices through Quantitative Easing (QE) can effectively influence inflation, but that the effects are quite uncertain, both in timing and direction.

Keywords: Quantitative Easing, Inflation, Financial markets

JEL Classification: E31, E44, E52