Inflation at risk in advanced and emerging market economies

BIS Working Papers  |  No 883  | 
04 September 2020


Discussion of inflation risks, especially whether risks to future inflation are balanced or tilted to the upside or downside, often take centre stage in central bank policy meetings and communication. Policymakers often consider not only the most likely future path of inflation but also the full range of possible outcomes around that path. However, there is limited research on inflation risks and the factors that drive them, even for emerging market economies (EMEs) where inflation has generally been higher and more volatile.


We investigate inflation risks and their drivers in a large sample of advanced and emerging market economies. The starting point of our analysis is a Phillips curve, a workhorse model that links inflation to its main determinants. To investigate inflation-at-risk, the Phillips curve is estimated as a quantile regression. We use this type of regression because it highlights when tail risks for inflation - that is, the chance of very high or low inflation - evolve differently from average outcomes.


We find that, across most economies, upside inflation risks have generally fallen over time. This reflects the adoption of inflation targeting frameworks and the success that central banks have had in controlling inflation. Relevant inflation risk drivers differ across groups of countries. In advanced economies, being at the zero lower bound raises the probability of very low inflation outcomes. In EMEs, large exchange rate depreciations raise the probability of high inflation outcomes. We also find that tightening financial conditions increase both upside and downside tail risks, especially in EMEs.


We examine how inflation risks have changed over time in a large panel of advanced and emerging market economies (EMEs). Quantile regressions show a general decline in upside inflation risks over time, reflecting successful disinflationary processes and the adoption of inflation targeting regimes. But important non-linearities remain. In advanced economies, the zero lower bound represents a prominent source of downside inflation risk. In EMEs, the exchange rate remains a powerful source of nonlinearity, with large exchange rate depreciations associated with upside inflation risks. Tightening financial conditions increase both up- and downside inflation risks.

JEL codes: E31, E37, E52

Keywords: inflation risk, monetary policy framework, zero lower bound, inflation targeting