Showing papers on "Inflation published in 1989"

Does Monetary Policy Matter? a New Test in the Spirit of Friedman and Schwartz

Abstract: This paper uses the historical record to isolate episodes in which there were large monetary disturbances not caused by output fluctuations. It then tests whether these monetary changes have important real effects. The central part of the paper is a study of postwar U.S. monetary history. We identify six episodes in which the Federal Reserve in effect decided to attempt to create a recession to reduce inflation. We find that a shift to anti-inflationary policy led, on average, to a rise in the unemployment rate of two percentage points, and that this effect is highly statistically significant and robust to a variety of changes in specification. We reach three other major conclusions. First, the real effects of these monetary disturbances are highly persistent. Second, the six shocks that we identify account for a considerable fraction of postwar economic fluctuations. And third, evidence from the interwar era also suggests that monetary disturbances have large real effects.

Real Exchange Rates, Devaluation, and Adjustment: Exchange Rate Policy in Developing Countries

Abstract: "Real Exchange Rates, Devaluation, and Adjustment "provides a unified theoretical and empirical investigation of exchange rate policy and performance in scores of developing countries. It develops a theory of equilibrium and disequilibrium real exchange rates, takes up the question of why devaluations are the most controversial policy measures in poorer nations, and discusses what determines their success or failure.In a lucid fashion, Edwards organizes vast amounts of data on exchange rates - both real and nominal - and discusses their effect on net trade balances, net asset positions, output growth, real wages, and rates of price inflation, analyzed both in time series and through cross country comparisons. Edwards's investigation singles out 39 major devaluation episodes for before and after comparative analyses while simultaneously isolating the separate effects of other important explanatory variables, such as bank credit expansion and changes in the terms of trade.The first part of the book focuses on theoretical models of devaluation and real exchange rate behavior in less developed countries. Special attention is paid to intertemporal channels in the transmission of disturbances. The second part uses a large cross country data set to analyze the way the real exchange rate has behaved in these nations. The data are also used to test the implications of several theories of real exchange rate determination. The third part analyzes actual devaluation experiences between 1962 and 1982. These chapters examine the events leading to a balance of payments crisis and to a devaluation, exploring the relation between macroeconomic disequilibrium, and the imposition of trade and exchange controls. They also investigate the effect of nominal devaluation on key variables such as the balance of payments, the current account, the real exchange rate, real output real wages, and income distribution.Sebastian Edwards is Professor of Economics at the University of California at Los Angeles and Research Associate at the National Bureau of Economic Research.

Does Monetary Policy Matter? A New Test in the Spirit of Friedman and Schwartz

Abstract: This paper uses the historical record to isolate episodes in which there were large monetary disturbances not caused by output fluctuations. It then tests whether these monetary changes have important real effects. The central part of the paper is a study of postwar U.S. monetary history. We identify six episodes in which the Federal Reserve in effect decided to attempt to create a recession to reduce inflation. We find that a shift to anti-inflationary policy led, on average, to a rise in the unemployment rate of two percentage points, and that this effect is highly statistically significant and robust to a variety of changes in specification. We reach three other major conclusions. First, the real effects of these monetary disturbances are highly persistent. Second, the six shocks that we identify account for a considerable fraction of postwar economic fluctuations. And third, evidence from the interwar era also suggests that monetary disturbances have large real effects.

Understanding Real Business Cycles

Abstract: he 1 960s were a time of great optimism for macroeconomists. Many economists viewed the business cycle as dead. The Keynesian model was the reigning paradigm and it provided all the necessary instructions for manipulating the levers of monetary and fiscal policy to control aggregate demand. Inflation occurred if aggregate demand was stimulated "excessively" and unemployment arose if demand was "insufficient." The only dilemma faced by policymakers was determining the most desirable location along this inflation-unemployment tradeoff or Phillips curve. The remaining intellectual challenge was to establish coherent microeconomic foundations for the aggregate behavioral relations posited by the Keynesian framework, but this was broadly regarded as a detail that should not deter policymakers in their efforts to "stabilize" the economy. The return of the business cycle in the 1970s after almost a decade of economic expansion, and the accompanying high rates of inflation, came as a rude awakening for many economists. It became increasingly apparent that the basic Keynesian framework was not the appropriate vehicle for understanding what happens during a business cycle nor did it seem capable of providing the empirically correct answers to questions involving changes in the economic environment or changes in monetary or fiscal policy. The view that Keynesian economics was an empirical success even if it lacked sound theoretical foundations could no longer be taken seriously. The essential flaw in the Keynesian interpretation of macroeconomic phenomenon was the absence of a consistent foundation based on the choice theoretic framework of microeconomics. Two important papers, one by Milton Friedman (1968) and the other by Robert Lucas (1976), forcefully demonstrated examples of

Financial Factors in Economic Development

Abstract: Financial factors have been assigned strategic importance in economic development. But very different factors have been isolated in the respective experiences: in Asia unrepressed financial markets in mobilizing saving and allocating investment have been given prominence. In Latin America the central question is the role of inflationary finance, the scope for deficits to enhance growth and, increasingly, the feedback from high and unstable inflation to poor economic performance. This paper reviews and contrasts the two approaches and concludes that the strong claims for the benefits of financial liberalization are not supported by evidence. Financial factors are important, but probably only when financial instability becomes a dominant force. The scope for inflationary finance is small and the risks are larger than commonly accepted. When hyperinflation takes over and foreign exchange crises disrupt the price system, and shorten the economic horizon to a week or a month, normal economic development is suspended. Moreover, difficult to reverse capital flight puts savings outside the home economy. Attention should focus on these extreme cases and explore deeper the thresholds at which financial factors become dominant and the channels through which this occurs. Superior growth performance, in this perspective, may be more a reflection of adaptability than financial deepening.

The Information in the Longer Maturity Term Structure about Future Inflation

Abstract: This paper provides empirical evidence on the information in the term structure for longer maturities about both future inflation and the term structure of real interest rates The evidence indicates that there is substantial information in the longer maturity term structure about future inflation: the slope of the term structure does have a great deal of predictive power for future changes in inflation On the other hand, at the longer maturities, the term structure of nominal interest rates contains very little information about the term structure of real interest rates These results are strikingly different from those found for very short-term maturities, six months or less, in previous work For maturities of six months or less, the term structure contains no information about the future path of inflation, but it does contain a great deal of information about the term structure of real interest rates The evidence in this paper does indicate that, at longer maturities, the term structure of interest rates can be used to help assess future inflationary pressures: when the slope of the term structure steepens, it is an indication that the inflation rate will rise in the future and when the slope falls, it is an indication that the inflation rate will fall However, we must still remain cautious about using the evidence presented here to advocate that the Federal Reserve should target on the term structure in conducting monetary policy A change in Federal Reserve operating procedures which focuses on the term structure may well cause the relationship between the term structure and future inflation to shift, with the result that the term structure no longer remains an accurate guide to the path of future inflation If this were to occur, Federal Reserve monetary policy could go far astray by focusing on the term structure of interest rates

Exchange Rate Pass-Through in the 1980s: The Case of U.S. Imports of Manufactures

Abstract: MOVEMENTS IN the exchange rate of the dollar are now widely perceived to have less impact on U.S. import prices than they had at the beginning of this decade. If that perception is accurate, a depreciation of the dollar may be less effective in bringing about adjustment in the real external balance, but it is also less likely to fuel inflation. We address three questions in this report. What are current estimates of the timing and magnitude of the effect of changes in the exchange rate on import prices? Has this relationship changed over the past decade? What would be the implications for U.S. import prices of a further fall in the dollar? Over the years, a substantial body of empirical research has addressed the question of the transmission of nominal exchange rate changes to import prices, either directly or as part of a discussion of how exchange rate changes might affect the trade balance. ' In fact, it is almost a rite of

Financial Factors in Economic Development

Abstract: Financial factors have been assigned strategic importance in economic development. But very different factors have been isolated in the respective experiences: in Asia unrepressed financial markets in mobilizing saving and allocating investment have been given prominence. In Latin America the central question is the role of inflationary finance, the scope for deficits to enhance growth and, increasingly, the feedback from high and unstable inflation to poor economic performance. This paper reviews and contrasts the two approaches and concludes that the strong claims for the benefits of financial liberalization are not supported by evidence. Financial factors are important, but probably only when financial instability becomes a dominant force. The scope for inflationary finance is small and the risks are larger than commonly accepted. When hyperinflation takes over and foreign exchange crises disrupt the price system, and shorten the economic horizon to a week or a month, normal economic development is suspended. Moreover, difficult to reverse capital flight puts savings outside the home economy. Attention should focus on these extreme cases and explore deeper the thresholds at which financial factors become dominant and the channels through which this occurs. Superior growth performance, in this perspective, may be more a reflection of adaptability than financial deepening.(This abstract was borrowed from another version of this item.)

Testing for the long run relationship between nominal interest rates and inflation using cointegration techniques

Abstract: (1989). Testing for the long run relationship between nominal interest rates and inflation using cointegration techniques. Applied Economics: Vol. 21, No. 4, pp. 439-447.

A positive theory of inflation and inflation variance

Abstract: A POSITIVE THEORY OF INFLATION AND INFLATION VARIANCE Empirically, inflation and the variance of inflation are positively associated. This paper develops a model that provides a potential explanation for this relationship in terms of the incentives facing the policymaker in a "discretionary equilibrium." The model can also account for an empirical association between inflation and measures of real output instability. There is, however, no direct causal link whatever from the average rate of inflation to either the variance of inflation or that of real output. I. INTRODUCTION The debate over the use rules or discretion in monetary policy has been central to macroeconomics for many years (e.g., Simons [1963]; Lucas [1980]; Buiter [1980]). Recently Kydland and Prescott [1977] and Barro and Gordon [1983a,b] have identified "discretion" as the absence of policy commitment in a game between policymakers and the public. They argued that discretionary policymaking will lead governments to create excessive inflation. A policy of low inflation is not consistent with incentives facing governments, and thus will not be believed by the private sector. Barro and Gordon [1983a] argue that this positive theory of monetary policy can help to explain many features of the trend rate of inflation in modern economies: high and persistent rates of inflation, a positive relationship between inflation and unemployment, and the observed countercyclical behaviour of monetary authorities, among others. These models are based on the premise that there are significant costs to a high but fully anticipated rate of inflation. Another feature of inflation in modern economics, however, is the well-documented fact that inflation and the variability of inflation are positively associated. This phenomenon has been widely observed over different countries at different times.(1) This has led researchers to question the feasibility of a steady and predictable positive rate of inflation. The finding suggests that high rates of inflation may reduce the ability to forecast future inflation rates. A high average inflation rate may add an unnecessary degree of uncertainty to individual decision making and lead to a misallocation of resources. Friedman [1977] suggests that this may cause output instability and possibly raise the average unemployed rate. A related paper by Logue and Sweeney [1981] establishes that there is a positive relationship between inflation and the variability of economic growth for industrial countries. Given this perspective, the welfare costs associated with inflation might be considerably higher than the traditional costs of anticipated inflation. This paper extends the Barro and Gordon [1983a] model of discretionary monetary policy to take account of the relationship between inflation and measures of inflation and output variability. The extension focussed on is to model an endogenous wage-indexing scheme in the labor market. In the discretionary equilibrium, wage setters not only form rational expectations of the future price level, but also choose an optimal degree of wage indexation. This extension to the basic model has the following properties of a discretionary equilibrium. 1. There is a positive association between the mean rate of inflation and the magnitude of real disturbances in the economy, as well as between the mean inflation rate and the degree of output instability in the economy. 2. In an economy where real disturbances are relatively important, there is a positive association between the mean rate of inflation and the variance of inflation. The explanation behind these results is as follows. The lower is the degree of wage indexation, the greater is the incentive for monetary authorities to cause surprise inflation, and hence the higher is the mean rate of inflation in a discretionary equilibrium. But the degree of wage indexation is negatively related to the variance of real disturbances in an economy which is subject to both real and nominal disturbances. …

The Inflation-Hedging Effectiveness of Real Estate

Abstract: Inflation has become one of the predominant financial concerns of the late twentieth century. In the late 1970s, public opinion polls ranked inflation as the number one problem in the United States...

Does Monetary Policy Matter? A New Test in the Spirit of Friedman and Schwartz

Abstract: This paper uses the historical record to isolate episodes in which there were large monetary disturbances not caused by output fluctuations. It then tests whether these monetary changes have important real effects. The central part of the paper is a study of postwar U.S. monetary history. We identify six episodes in which the Federal Reserve in effect decided to attempt to create a recession to reduce inflation. We find that a shift to anti-inflationary policy led, on average, to a rise in the unemployment rate of two percentage points, and that this effect is highly statistically significant and robust to a variety of changes in specification. We reach three other major conclusions. First, the real effects of these monetary disturbances are highly persistent. Second, the six shocks that we identify account for a considerable fraction of postwar economic fluctuations. And third, evidence from the interwar era also suggests that monetary disturbances have large real effects.

The Macroeconomics of Populism in Latin America

Abstract: By populism, this paper refers to an economic approach that emphasizes growth and income redistribution and deemphasizes the risks of inflation and deficit finance, external constraints and the reaction of economic agents to aggressive nonmarket policies. It analyzes two instances of populism - Chile under Allende and Peru under Garcia. These experiences are described in detail, not as a righteous assertion of conservative economics, but as a warning that populist policies ultimately fail, and always at a frightening cost to the groups they were supposed to benefit. This paper explores the question of whether some variant of populist policies could succeed. It suggests that populist policies could succeed if they stayed clear of foreign exchange constraints, emphasized reactivation for a brief initial period, and then shifted to growth policies. Most important, expansionary policies must reflect awareness of capacity constraints and must rely for financing on an extremely orthodox fiscal policy and rigorous tax adminsitration. The paper concludes by warning that IMF-style policies, unconcerned with growth of social progress, may establish financial stability in the short run, but inevitably open the door to yet another round of destructive reaction in the form of populist policies.

Empirical Analysis of High-Inflation Episodes in Argentina, Brazil, and Israel

Abstract: Although accommodative policies and widespread indexation may account for the persistence of high inflation, they cannot explain changes in the inflation rate. The causes of such changes for the high-inflation episodes immediately preceding the recent "heterodox" attempts at stabilization in Argentina, Brazil, and Israel are examined by computing historical decompositions of these episodes based on vector autoregressions, distinguishing between the "fiscal" and "balance of payments" views of their causes. In all three cases, nominal exchange rate shocks played the dominant role in triggering an acceleration of inflation.

On the Existence of a Political Monetary Cycle

Abstract: This paper examines electoral influence on monetary policy as measured by Ml money growth. I find a significant four-year electoral cycle in money growth even when controlling for the influence of interest rates, income, and budget deficits. Further, the residual electoral cycle produces the income and inflation movements associated with the political business cycle when it is used in simulations of simple reduced form macro models. The paper concludes by discussing the difficulties in rationalizing cyclical monetary policy with rational expectations.

Costs of Inflation

Abstract: We review theoretical and empirical analyses of the costs of inflation. Part 2 of the paper examines microeconomic models in which inflation is perfectly anticipated, and viewed as the only distortion in the economy or as one of many distortionary taxes, which may or may not be chosen optimally. Part 3 turns to stochastic models with a more macroeconomic orientation, in which inflation is imperfectly perceived, or where real costs of price adjustment cause agents not to adjust fully in the presence of inflation. Part 4 discusses empirical work, which largely focuses on the relationship between the level of inflation, its variability, its unpredictability, and variation in relative prices.

A comparison of lag–length selection techniques in tests of Granger causality between money growth and inflation: evidence for the US, 1959–86

Abstract: This paper employs the Granger test to examine the causal relationship between growth in the money supply and inflation for the US over the period 1959 to 1986. Alternative procedures, including both statistical search and non–statistical ad hoc methods, are utilized to determine the order of the bivariate distributed lag models used in implementing the test. In general, the results show feedback between movements in the money supply and price level changes. Unlike the results of Thornton and Batten (1985), one of the ad hoc methods for lag–length determination is found to perform somewhat better than the statistical search methods in correctly assessing the causal relationships involving money growth and inflation.

Assessing the Federal Reserve's Measures of Capacity and Utilization

Abstract: IN LATE 1988, capacity utilization in U.S. industry reached its highest level since early 1979. As measured by the Federal Reserve Board, capacity utilization in manufacturing industries was 84.6 percent in December 1988, a dramatic increase from the 70.3 percent trough of the 1982 recession. The 84.6 percent rate exceeds the postwar average by about a standard deviation, yet is still more than a standard deviation below the postwar maximum. These relatively high and increasing rates of capacity utilization have, at least in some quarters, been taken as a signal that the long expansion that began in 1983 is drawing to its inevitable close. To some observers, moreover, higher utilization suggests a risk of accelerating inflation and the need for caution on the part of the Federal Reserve Board. ' Specifically, high measured capacity utilization is taken as a sign that the decomposition of nominal output growth into real growth and inflation has grown less favorable and that contractionary monetary policy is in order. Capacity utilization is clearly one of the variables that the Federal Reserve's Open Market Committee (FOMC) considers, although there is some dispute about how it is to be interpreted. At a November 1, 1988,

The Return of the Liquidity Effect: A Study of the Short-Run Relation Between Money Growth and Interest Rates

Abstract: In this article, I use band-pass filters to investigate the short-run relationship between money growth and interest rates. I find a negative correlation between short-run movements in money growth and interest rates, which I interpret as evidence that the liquidity effect dominates the anticipated inflation effect.

Wage Growth and the Inflation Process: An Empirical Note

Abstract: A central proposition in the Phillips curve view of the inflation process is that prices are marked up over productivity-adjusted labor costs. If that is true, then long-run movements in prices and labor costs must be correlated. If long-run movements in a time series are modeled as a stochastic trend, then the above noted implication of the 'price markup' view is related to the concept of cointegration discussed in Granger (1986), which says that cointegrated multiple time series share common stochastic trends. The evidence reported here shows that time series measuring rates of change in prices and labor costs are cointegrated. Furthermore, this cointegration appears consistent with Granger-causality running from the rate of change in prices to the rate of change in labor costs, but not vice versa as suggested by the 'price markup' view.

The theory and measurement of macroeconomic disequilibrium in centrally planned economies

Abstract: The motivation for my research on CPE macroeconomics has been to elucidate the general problem of macroeconomic equilibrium and, in a specific application, to evaluate the evidence for repressed inflation in the consumption goods markets of the ‘classical’ Soviet-type economies of Eastern Europe. This empirical testing required a more elaborate and general macroeconomics than was then available for the CPEs. A prerequisite was to clarify the appropriate concept of ‘equilibrium’ (see Muellbauer and Portes, 1978, for market economies, and Dlouhy, 1984, in the CPE context). An equilibrium with quantity rationing is a state in which markets do not clear, but the economy is at rest, and we can in principle measure the magnitude of ‘disequilibrium’ in terms of the distance from a market-clearing allocation or price vector. Similarly, Kornai (1980) discusses a self-reproducing equilibrium state of an economy characterized by pervasive shortages which he subsequently seeks to measure (1982).

Credibility, debt and unemployment: Ireland's failed stabilization

Abstract: Ireland's disinflation Rudiger Dornbusch Disinflation requires a switch to tough policies. If these are fully and immediately reflected in expectations and actual prices, there need be little output cost of disinflation. This paper analyses the stabilization programme in Ireland in the 1980s. It may be that EMS membership offers a credibility bonus: by joining the EMS, playing by the rules of fixed exchange rates and tying the currency to German price stability, a country can achieve a dramatic turnaround in expectations, inflation, and long interest rates. But the evidence shows international disinflation in the 1980s was not limited to EMS members. The Irish example demonstrates a second lesson. Disinflation and tight money have been accompanied by a serious public debt problem and soaring unemployment. Unless these problems can be tackled it may become necessary in future to resort once more to inflation and the printing press. Long interest rates suggest that the bond market does not yet take such fear seriously.

The determinants of japan's saving rate: the impact of the age structure of the population and other factors

Abstract: In this paper, I analyze the determinants of saving in Japan using national income accounts data for the 1955-87 period. My results suggest that the age structure of the popu lationis the primary determinant of both trends over time in Japan's saving rate and the high level thereof relative to the other developed countries and that Japan's saving rate can be expected to decline sharply due to the rapid increase in the ratio of the aged population to the working-age population. The level and rate of growth of income, wealth, (in the case of private and national saving) the unemployment rate, and (in the case of household saving) inflation are also found to influence the level of saving in Japan, and Japanese households are found to see through the corporate veil to some extent but not through the government veil.

The effects of interest rates on savings in developing countries

Abstract: This paper provides evidence on the effects of interest rates on savings in developing countries. While the evidence is not conclusive, time-series estimates for individual countries as well as cross-section and time-series estimates for a number of countries point to the positive effects of interest rates on savings. At the same time, a variety of factors may have reduced the statistical significance of the estimates. The author points out that estimates of savings in developing countries are subject to considerable error. Also there are other errors associated with the measurement of interest rates and inflation rates, which are necessary to derive real interest rates. Finally, there is evidence that negative real interest rates bring a shift to gold, real estate, and consumer durables, which latter are included in savings as measured in national income statistics.

Inflation control for air supports

Abstract: A method of controlling the inflation of a body support, such as a mattress, having a plurality of air cells. The user is placed on the mattress and the air cells are inflated to provide the desired support in each of a plurality of positions. The height distance of all of the air cells are measured in each of the positions and respective positions. The position of the user on the mattress is determined from the height measurements and the inflation of the air cells is controlled to use the stored standards for the position of the user.