The Natural Rate Puzzle: Global Macro Trends and the Market-Implied r*

Abstract

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The Determinants of Bond-Stock Correlation: the Role of Trend Inflation and Monetary Policy

“…where π is the steady state inflation, and ϵ π t ∼ N (0, σ 2 π ) is an independently and identically distributed shock to inflation target (Ireland, 2007;Cogley et al, 2010;Justiniano et al, 2013). It has been documented in the literature that inflation contains very low frequency variation (Coibion and Gorodnichenko, 2011), which also has important implications for asset pricing dynamics (Cieslak and Povala, 2015;Davis et al, 2019;Bauer and Rudebusch, 2020). Equation ( 41) is one way to incorporate low frequency variation in inflation by incorporating stochastic target inflation.…”

“…Bianchi et al (2016) build and estimate a regime switching model and show that regime change in monetary policy has large and long-lasting effects on asset prices. Cieslak and Povala (2015), Davis et al (2019), andBauer andRudebusch (2020) study the implications of persistent components of inflation (or trend inflation) on asset prices. These papers find that incorporating slow moving parts of inflation significantly improves the explanatory power of asset pricing models for explaining long-term bonds.…”