Inflation at Risk

We investigate how macroeconomic drivers influence the predictive inflation distribution and establish two key findings. First, the recent muted response of the conditional mean of inflation to economic conditions does not convey a complete picture of inflation dynamics. Indeed, we find ample variability in the tails of the inflation outlook that remains even when focusing on the most recent period of stable and low \emph{mean} inflation. Second, we document that tight financial conditions carry substantial downside inflation risks in the United States and in the Euro Area, a feature overlooked by much of the literature but consistent with financial amplification mechanisms. Finally, we show that evidence from financial market quotes, from survey data and from a regime-switching model of inflation is consistent with our findings and use our model to track inflation risks during the Covid-19 crisis.