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Prices and returns: Role of inflation

We find that the market dividend yield and earnings yield can positively predict future inflation internationally. The inflation predictability of price ratios could invert the standard asset pricing predictive results. For example, dividend yields do forecast real dividend growth but not nominal dividend growth. We extend the analysis to the earnings yield as a robust analysis and document a similar predictive pattern. Further term structure analysis suggests that the financial ratio variation decomposition also differs significantly in nominal and real terms. In nominal-term decomposition, discount rate news is found to be the primary contributor to variations in price ratios while in real-term decomposition, cash flow news plays a more significant role, with its importance increasing over longer investment horizons. Our study utilizes consistent inflation predictability evidence in advanced economies to re-evaluate the global relationship between price ratios and inflation. We confirm that inflation is an international state variable in post-1970s samples and that the correlation between inflation and price ratios can almost entirely be attributed to the relationship between expected inflation and future growth prospects. This finding offers an explanation for the previously puzzling correlation between the dividend-price ratio and future inflation.

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China’s GDP-at-Risk: Real-Time Monitoring, Risk Tracing, and Macroeconomic Policy Effects

Timely monitoring GDP-at-risk and tracing economic downside risk sources can help establish effective risk warning and prevention systems. This study constructs a probability distribution for China’s economic growth with skewness determined by a multidimensional predictor information set of macro fundamentals. Such a treatment allows us to identify changing drivers of economic downside risks during monitoring GDP-at-risk’s dynamic evolutionary path. We also employ a time-varying parameter vector autoregression model with random volatility to explore the heterogeneous impacts of different macroeconomic policy instruments on economic slowdowns. Our results provide empirical support for macroeconomic management and policy formulation in emerging markets. We reach three conclusions. First, the dynamics of GDP-at-risk exhibit significant event-driven characteristics, and economic downside risk increases significantly under the influence of extreme events. Moreover, the probability distribution of economic growth is asymmetric--as the downside risk of the economy increases, its upside potential increases disproportionately. Second, the time-varying risk trace of GDP-at-risk shows that the contribution of financial conditions and local government debt to economic downside risk declines. The importance of the risk-driving role of housing price growth gradually increases, suggesting that China’s property prices can provide more valuable early warning information about future growth risk, allowing time for precise preventive measures. Nevertheless, interest rates and inflation as risk divers have consistently minimal impacts. Third, the heterogeneity impulse response function of GDP-at-risk suggests that quantity-based monetary policy and fiscal policy can manage economic downside risks in the short run. In contrast, price-based monetary policy can curb economic overheating and reduce downside risks in the medium to long term. Therefore, the effect of price-based monetary policy is more sustainable in China.

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‘Making text talk’: The minutes of the Central Bank of Brazil and the real economy

This paper investigates the relationship between the views expressed in the minutes of the meetings of the Central Bank of Brazil's Monetary Policy Committee (COPOM) and the real economy. It applies various linguistic machine learning algorithms to construct different measures of the uncertainty contained in the minutes of the COPOM. To achieve this, we first infer the content of the paragraphs of the minutes with Latent Dirichlet Allocation (LDA). Secondly, we build an uncertainty index for the minutes with Word Embedding and K-Means. Thirdly, we create two topic-uncertainty indices. The first topic-uncertainty index is constructed from paragraphs with a higher probability of topics related to general economic conditions. The second topic-uncertainty index is built from paragraphs with a higher probability of topics related to inflation and the monetary policy decision. Then, via a Structural VAR, we explore the lasting effects of these uncertainty indices on some Brazilian macroeconomic variables. Our results show that an unexpected increase in the minutes' uncertainty leads to a depreciation of the exchange rate and a decline in industrial production and retail trade. Moreover, we show that a positive shock to the general economic conditions topic-uncertainty index leads to higher inflation, whereas a positive shock to the inflation and monetary policy decision topic-uncertainty index leads to lower inflation.

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Blowing against the Wind? a narrative approach to central Bank foreign exchange intervention

Most countries in the world use foreign exchange intervention, but measuring the success of the policy is difficult. By using a narrative approach, I identify interventions when the central bank manages to influence the exchange rate based on pure luck. I separate them from interventions when the central bank actually impacted the exchange rate. Because intervention records are daily aggregates, an intervention might appear to have changed the direction of the exchange rate, when it is more likely to have been caused by market news. This analysis allows to have a better understanding of how successful central bank operations really are. I use new daily data on Bank of England interventions in the 1980 s and 1990 s. Some studies find that interventions work in up to 80 % of cases. Yet, by accounting for intraday market moving news, I find in adverse conditions, the Bank of England managed to influence the exchange rate only in 8 % of cases. I use natural language processing to confirm the validity of the narrative approach. Using lasso and a VAR analysis, I investigate what makes the Bank of England intervene. I find that only movement on the Deutschmark and not US dollar exchange rate made the Bank intervene. Also, I find that interest rate hikes were mostly a tool for currency management and accompanied by large reserve sales.

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