The Federal Reserve Board published a FEDS Note analysing how inflation uncertainty has become highly correlated across countries since the COVID-19 pandemic and how shocks to inflation uncertainty abroad transmit into domestic inflation uncertainty, monetary policy rates and investment. Using a predictive-data-based measure of inflation uncertainty, the note finds that higher foreign inflation uncertainty, even after stripping out the portion correlated with domestic uncertainty, is followed on average by higher domestic inflation uncertainty, lower future policy rates and weaker domestic investment. U.S. inflation uncertainty is described as remaining exceptionally elevated after the pandemic and reaching a record high in March 2023 at around four standard deviations above its 1980 to 2023 historical mean, with similarly elevated uncertainty across advanced and emerging market economies. Panel regressions across country pairs (with controls including inflation levels, policy rates, the VIX and a COVID-period dummy for 2020:Q1 to 2022:Q2) show that spillovers are smaller than domestic effects but economically meaningful. A three standard deviation increase in foreign inflation uncertainty, comparable to the cross-country average shock in March 2023, is associated with a 2.55 percent fall in investment after six quarters, compared with a 4.9 percent fall following a similarly sized domestic uncertainty shock. The note also finds that monetary policy rate differentials modulate the transmission to investment, with spillover effects varying across counterpart countries, and illustrates for the United States that a four standard deviation foreign uncertainty shock is followed by an investment decline of over 2 percent after six quarters, with stronger effects when foreign policy rates are below U.S. rates. The analysis reflects the authors’ views and not necessarily those of the Board of Governors.
Federal Reserve Board 2025-01-16
Federal Reserve Board research finds foreign inflation uncertainty spills over into domestic policy rates and investment
The Federal Reserve Board's FEDS Note examines post-COVID-19 inflation uncertainty across countries and its impact on domestic inflation, monetary policy rates, and investment. Foreign inflation uncertainty significantly affects domestic conditions, with a three standard deviation increase linked to a 2.55% investment decline after six quarters. The study highlights that monetary policy rate differentials influence these spillover effects, with stronger impacts when foreign rates are below U.S. rates.