Showing papers on "Inflation published in 1995"

Inflation and Economic Growth

Abstract: Data for around 100 countries from 1960 to 1990 are used to assess the effects of inflation on economic performance. If a number of country characteristics are held constant, then regression results indicate that the impact effects from an increase in average inflation by 10 percentage points per year are a reduction of the growth rate of real per capita GDP by 0.2-0.3 percentage points per year and a decrease in the ratio of investment to GDP by 0.4-0.6 percentage points. Since the statistical procedures use plausible instruments for inflation, there is some reason to believe that these relations reflect causal influences from inflation to growth and investment. However, statistically significant results emerge only when high- inflation experiences are included in the sample. Although the adverse influence of inflation on growth looks small, the long-term effects on standards of living are substantial. For example, a shift in monetary policy that raises the long-term average inflation rate by 10 percentage points per year is estimated to lower the level of real GDP after 30 years by 4-7%, more than enough to justify a strong interest in price stability.

Optimal contracts for central bankers

Abstract: This paper adopts a principal-agent framework to determine how a central banker's incentives should be structured to induce the socially optimal policy. In contrast to previous findings using ad hoc targeting rules, the inflation bias of discretionary policy is eliminated and an optimal response to shocks is achieved by the optimal incentive contract, even in the presence of private central-bank information. In the one-period model that has formed the basis for much of the literature on discretionary monetary policy, it is shown that the optimal contract ties the rewards of the central banker to realized inflation. Copyright 1995 by American Economic Association.

Inflation Crises and Long-Run Growth

Abstract: After excluding countries with high-inflation crises - periods when annual inflation is above 40 percent - the data reveal no evidence of a consistent relationship between growth and inflation, at any frequency. But growth does tend to fall sharply during discrete crises of high inflation and to recover surprisingly strongly after inflation falls. Perhaps inflation crises are purely cyclical, or perhaps in the long run they have a favorable purgative effect. Recent literature suggests that long-run averages of growth and inflation are only weakly correlated and that such correlation is not robust to the exclusion of observations of extreme inflation. Including time series panel data has improved matters, but an aggregate parametric approach remains inconclusive. Bruno and Easterly propose a nonparametric definition of high-inflation crises as periods when annual inflation is above 40 percent. Excluding countries with high-inflation crises, they find no evidence of a consistent relationship between growth and inflation, at any frequency. They do find that growth falls sharply during discrete crises of high inflation, then recovers surprisingly strongly after inflation falls. The fall in growth during a crisis and the recovery of growth after the crisis tend to average out to nearly zero (even slightly above zero); hence no robust cross-section correlation. Their findings could be consistent either with trend stationarity of output (in which inflation crises are purely cyclical phenomena) or with models in which crises have a favorable long-run purgative effect. Their findings do not support the view that reducing high inflation carries heavy output costs in the short to medium run. This paper - a joint product of the Office of the Vice President, Development Economics, and the Macroeconomics and Growth Division, Policy Research Department - is part of a larger effort in the Bank to examine the determinants of economic growth.

Inflation and Economic Growth

Abstract: Data for around 100 countries from 1960 to 1990 are used to assess the effects of inflation on economic performance. If a number of country characteristics are held constant, then regression results indicate that the impact effects from an increase in average inflation by 10 percentage points per year are a reduction of the growth rate of real per capita GOP by 0.2-0.3 percentage points per year and a decrease in the ratio of investment to GOP by 0.4-0.6 percentage points. Since the statistical procedures use plausible instruments for inflation, there is some reason to believe that these relations reflect causal influences from inflation to growth and investment. However, statistically significant results emerge only when high-inflation experiences are included in the sample. Although the adverse influence of inflation on growth looks small, the long-term effects on standards of living are substantial. For example, a shift in monetary policy that raises the long-term average inflation rate by 10 percentage points per year is estimated to lower the level of real GOP after 30 years by 4-7%, more than enough to justify a strong interest in price stability.

Price Level Determinacy Without Control of a Monetary Aggregate

Abstract: It is shown that the price level remains determinate even in the case of two kinds of radical money supply endogeneity -- an interest rate peg by the central bank, and a 'free banking' regime -- that are commonly supposed to imply loss of control of the price level. Price level determination under such regimes can be understood in terms of a 'fiscal theory of the price level,' according to which the equilibrium price level is that level that makes the real value of nominally denominated government liabilities equal to the present value of expected future government budget surpluses. The application of the fiscal theory of the price level to exogenous-money regimes is sketched as well.

Warm Inflation

Abstract: Assuming a first order phase transition during inflation, a model scenario is described which does not require a tiny coupling constant Thermal equilibrium is closely maintained as inflation commences No large scale reheating is necessary Solutions for $N> 70$ are found for any $\delta \rho / \rho$ in the range $10^{-5} - 10^{-3}$

Optimal Inflation Targets, `Conservative' Central Banks, and Linear Inflation Contracts

Abstract: Inflation target regimes (like those if New Zealand, Canada, U.K., Sweden and Finland) are interpreted as having explicit inflation targets and implicit output/unemployment targets. Without output/unemployment persistence, delegation of monetary policy to a discretionary instrument-independent central bank with an optimal inflation target can eliminate the discretionary inflation bias, mimic the optimal linear inflation contract suggested by Walsh and extended by Persson and Tabellini, and achieve the equilibrium corresponding to an optimal rule with commitment. Thus an 'inflation target-conservative' central bank with an inflation target equal to the socially best inflation rate less any inflation bias dominates a Rogoff 'weight-conservative' central bank with increased weight on inflation stabilization, which suboptimally increases output/unemployment variability. With output/unemployment presistence, a constant inflation target is equivalent to a constant linear inflation contract. They can both eliminate the average inflation bias but not the state-contingent part of the inflation bias. Inflation variability is too high, and output variability too low, compared to the equilibrium corresponding to an optimal rule. An optimal state-contingent inflation target can remove all inflation bias, but in contrast to an optimal-state-contingent llinear inflation contract it still leaves inflation variability too high. Delegation with an optimal state-contingent inflation target to a Rogoff 'weight-conservative' central bank can then achieve the equilibrium corresponding to an optimal rule. Inflation targets mau on average be exceeded, and they may have imperfect credibility. Nevertheless they may usefully reduce inflation, and they appear much easier to implement than linear inflation contracts.

Measuring Core Inflation

Abstract: In this paper we argue that measured (RPI) inflation is conceptually mismatched with core inflation: the difference is more than just "measurement error". We propose a technique for measuring core inflation, based on an explicit long-run economic hypothesis. Core inflation is defined as that component of measured inflation that has no (medium-to) long-run impact on real output - a notion that is consistent with the vertical long-run Phillips curve interpretation of the co-movement in inflation and output. We construct a measure of core inflation by placing dynamic restrictions on a vector autoregression (VAR) system.

The Exchange Rate in the Presence of Transaction Costs: Implications for Tests of Purchasing Power Parity

Abstract: With transaction costs for trading goods, the nominal exchange rate moves within a band around the nominal purchasing power parity (PPP) value. We model the behavior of the band and of the exchange rate within the band. The model explains why there are below-unity slope coefficients in regression tests of PPP, and why these increase toward unity under hyperinflation or with low-frequency data. Our results are independent of the presence of nontraded goods in the economy. THE OBJECTIVE OF THIS article is to develop a model of the exchange rate that explains the following two stylized empirical facts about deviations from relative purchasing power parity (PPP). First, in a simple regression of changes in (nominal) exchange rates on inflation differentials, the slope coefficient is typically below unity. Second, the slope coefficient increases with the length of the observation interval, and the PPP link is also stronger under hyperinflation than under modest inflation.1 The low coefficients in the relative PPP regression, especially when tested over short periods of time, are often ascribed to errors-in-variables biases that arise from, for example, infrequent price sampling for some items, nonsynchroneity among the prices composing the index, relative price effects in price indices that are weighted differently across countries, and the presence of nontradable goods.2 In this article we present a complementary explanation for the stylized empirical facts, and show that below-unity regression coefficients are expected even when none of these errors in variables are present. We focus on the effect of costs for trading goods-such as shipping and insurance costs, tariffs, and information costs-on the nominal exchange rate.

Economic Effects and Structural Determinants of Capital Controls

Abstract: The effects and determinants of capital controls are studied using panel data for 61 countries. Capital controls are more likely in countries with lower income, a large government, and a central bank with limited independence. Other determinants of controls include the exchange rate regime, current account imbalances, and the degree of openness of the economy. Capital controls are found to be associated with higher inflation and lower real interest rates. No robust correlation is found between our measures of controls and economic growth, although there is evidence that countries with large black market premiums on foreign exchange grow more slowly.

Sticky Prices: New Evidence from Retail Catalogs

Abstract: This paper presents new results on the size, frequency, and synchronization of price changes for twelve selected retail goods over the past 35 years. Three basic facts about the data are uncovered: first, nominal prices are typically fixed for more than one year although the time between changes is very irregular; second, prices change more often during periods of high overall inflation; third, when prices do change, the sizes of the changes are widely dispersed. Both 'large' and 'small' changes occur for the same item and the sizes of these changes do not closely depend on overall inflation.

Long Memory in Inflation Rates: International Evidence

Abstract: We examine monthly inflation rates of five industrial countries. The application of tests against stationarity as well as tests against a unit root yield contradictory results. Thus fractional integration allowing for long memory is a plausible model. We discuss and apply the periodogram regression to estimate the difference parameters. For all countries we find estimates significantly different from 1 as well as from 0. This is evidence in favor of long memory. Specification tests and maximum likelihood estimates support the fitted models. Finally, we relate our empirical results to the construction of the data.

Declarations Are Not Enough: Financial Sector Sources of Central Bank Independence

Abstract: This paper seeks to explain the pattern of central bank independence prior to the recent fashion for its adoption. The sources of central bank independence matter for economic outcomes because it is by no means clear that such independence is self-enforcing. Since central bankers know that exercise of their independence can be curtailed, they will only pursue counterinflationary policies consistently when there exists an interest group that can protect them politically from the costs of doing so. This paper argues that the financial sector is the most prominent such group, and that central bank independence-and inflation-varied across countries from 1950 to 1989 according to national differences in effective financial opposition to inflation. The results of this analysis have two major policy implications: (1) moves to central bank independence in countries where appropriate political support does not exist may not reduce inflation over the long term; (2) financial deregulation will affect inflation level...

Relative price changes as aggregate supply shocks

Abstract: This paper proposes a theory of supply shocks, or shifts in the short-run Phillips curve, based on relative-price changes and frictions in nominal price adjustment. When price adjustment is costly, firms adjust to large shocks but not to small shocks, and so large shocks have disproportionate effects on the price level. Therefore, aggregate inflation depends on the distribution of relative-price changes: inflation rises when the distribution is skewed to the right, and falls when the distribution is skewed to the left. We show that this theoretical result explains a large fraction of movements in postwar U. S. inflation. Moreover, our model suggests measures of supply shocks that perform better than traditional measures, such as the relative prices of food and energy.

Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories

Abstract: This paper uses a unified analytical framework to assess, both qualitatively and quantitatively, the relevance of the different hypotheses that have been proposed to explain the real effects of exchange-rate-based stabilizations. The four major hypotheses analyzed are: (1) the supply-side effects associated with an inflation decline; (2) the perception that the exchange-rate peg is temporary; (3) the fiscal adjustments that tend to accompany the peg; and (4) the existence of nominal rigidities in wages or prices.

Cultural capital and social exclusion: some observations on recent trends in education, employment and the labour market

Abstract: The dominant forms of cultural capital associated with middle class access to `bureaucratic' careers are being devalued due to credential inflation and changing patterns of symbolic control within ...

Inflation and Uncertainty: Tests for Temporal Ordering

Abstract: For the postwar United States, increases in the rate of inflation tend to precede increases in the level of inflation uncertainty. The finding suggests that higher inflation uncertainty is part of the welfare cost of inflation. Possible explanations are (1) a high rate of inflation increases uncertainty about future monetary policy and (2) there is uncertainty about the persistence of inflation. Copyright 1995 by Ohio State University Press.

Do Expected Shifts in Inflation Affect Estimates of the Long-Run

Abstract: Recent empirical studies suggest that nominal interest rates and expected inflation do not move together one-for-one in the long run, a finding at odds with many theoretical models. This article shows that these results can be deceptive when the process followed by inflation shifts infrequently. We characterize the shifts in inflation by a Markov switching model. Based upon this model's forecasts, we reexamine the long-run relationship between nominal interest rates and inflation. Interestingly, we are unable to reject the hypothesis that in the long run nominal interest rates reflect expected inflation one-for-one. THE EX ANTE REAL interest rate affects all intertemporal savings and investment decisions in the economy. As such, the behavior of the ex ante real rate plays a central role in the dynamics of asset prices over time. Understanding the ex ante real interest rate and its relationship with other variables such as inflation is therefore a central issue in the study of financial markets. Our aim in this article is to explain some puzzling aspects of the postwar data revealed by recent research on the long-run behavior of the ex ante real interest rate. Rose (1988), King and Watson (1992), Mishkin (1992), and Crowder and Hoffman (1992) present evidence that real rates are subject to permanent disturbances. These findings are puzzling because, as Rose (1988) points out, they seem to directly contradict the first-order conditions of standard intertemporal models: when real interest rates are subject to permanent disturbances, these models predict that consumption growth rates should also be affected by permanent disturbances, a hypothesis easily rejected in the data. In this article, we provide an explanation for the apparently puzzling evidence suggesting that real interest rates are affected by permanent shocks. In particular, we consider information about the long-run behavior of the ex ante real interest rate inherent in the long-run behavior of nominal interest rates and inflation through the Fisher identity (Fisher (1930)).

Do expected shifts in inflation affect estimates of the long-run Fisher relation?

Abstract: Recent empirical studies suggest that nominal interest rates and expected inflation do not move together one-for-one in the long run, a finding at odds with many theoretical models. This article shows that these results can be deceptive when the process followed by inflation shifts infrequently. We characterize the shifts in inflation by a Markov switching model. Based upon this model's forecasts, we reexamine the long-run relationship between nominal interest rates and inflation. Interestingly, we are unable to reject the hypothesis that in the long run nominal interest rates reflect expected inflation one-for-one.

Some Monetary Facts

Abstract: This article describes three long-run monetary facts derived by examining data for 110 countries over a 30-year period, using three definitions of a country’s money supply and two subsamples of countries: (1) Growth rates of the money supply and the general price level are highly correlated for all three money definitions, for the full sample of countries, and for both subsamples. (2) The growth rates of money and real output are not correlated, except for a subsample of countries in the Organisation for Economic Co-operation and Development, where these growth rates are positively correlated. (3) The rate of inflation and the growth rate of real output are essentially uncorrelated.

Nonlinear Pricing and Oligopoly

Abstract: We consider the general problem of price discrimination with nonlinear pricing in an oligopoly setting where firms are spatially differentiated. We characterize the nature of optimal pricing schedules, which in turn depends importantly upon the type of private inflation the customer possesses - either horizontal uncertainty regarding brand preference or vertical uncertainty regarding quality preference. We show that as competition increases, the resulting quality distortions decrease, as well as price and quality dispersions. Additionally, we indicate conditions under which price discrimination may raise social welfare by increasing consumer surplus through encouraging greater entry.

Independent Central Banks: Low Inflation at No Costs?

Abstract: A widely held view suggests that politically independent central banks bring about relatively low and stable inflation rates.' A more debated question is whether one has to "pay" for this good outcome with more "real" instability. In his seminal contribution, Kenneth Rogoff (1985) suggests that an independent and inflation-averse central bank reduces average inflation but, as a result, increases output variability; the "conservative" central banker reduces the inflation bias, due to the time-inconsistency problem, but stabilizes less. However, Alesina and Summers (1993) do not find that, at least within the OECD countries, more independent central banks are associated with more variability of growth or unemployment. Thus, they conclude that independent central banks bring about low inflation at no apparent "real" costs. The point of this paper is to provide theoretical underpinnings to this finding, which is in contrast to Rogoff (1985).2 The basic idea is that one can isolate two sources of output variability. One is the "economic" variability induced by "standard" exogenous shocks that monetary policy is supposed to stabilize, for instance, money demand shocks or supply shocks. The second source of variability is "political" or, more generally, policy-induced. This is the variability introduced in the system by the uncertainty about the future course of policy. For instance, Alesina (1987) studies the effect of uncertain electoral outcomes in a model where the two contending parties have different preferences over inflation and unemployment. An inflation-averse, independent central banker does not stabilize as much the "economic" variability, in order to keep inflation low and stable. This is Rogoff's point. However, by insulating monetary policy from political pressures, an independent central bank can reduce the "political" variability. The overall effect of independence on output variability is, thus, ambiguous. This result is consistent, at least prima facie, with the evidence in Alesina and Summers (1993) on the lack of correlation between centralbank independence and output variability. In fact, it is possible that when the politically induced output variability is predominant, a more independent central bank reduces average inflation and the variance of output.

Does the nominal exchange rate regime matter

Abstract: The relevance of the exchange rate regime for macroeconomic performance remains a key issue in international macroeconomics. We use a comprehensive dataset covering nine regime-types for one hundred forty countries over thirty years to examine the link between the regime, inflation, and growth. Two sturdy stylized facts emerge. First, inflation is both lower and more stable under pegged regimes, reflecting both slower money supply and faster money demand growth. Second, real volatility is higher under pegged regimes. In contrast, growth varies only slightly across regimes, though investment is somewhat higher and trade growth somewhat lower under pegged regimes. Pegged regimes are thus characterized by lower inflation but more pronounced output volatility.

An EOQ Model for Deteriorating Items with Linear Time-dependent Demand Rate and Shortages Under Inflation and Time Discounting

Abstract: An economic order quantity (EOQ) inventory model for deteriorating goods is developed with a linear, positive trend in demand allowing inventory shortages and backlogging. The effects of inflation and the time-value of money are incorporated into the model, considering two separate inflation rates: namely, the internal (company) inflation rate and the external (general economy) inflation rate. It is assumed that the goods in the inventory deteriorate over time at a constant rate θ. The inventory policy is discussed over a finite time-horizon with several reorder points. The results are discussed with a numerical example and a sensitivity analysis of the optimal solution with respect to the parameters of the system is carried out. Several particular cases of the model are discussed in brief.

International Currency Experience: New Lessons and Lessons Relearned

Abstract: THE BROOKINGS PANEL on Economic Activity first met twenty-five years ago, at a moment of temporary reprieve but ominous portent for the international monetary system. The Bretton Woods system of pegged but adjustable dollar exchange rates had permitted the world economy more than two decades of robust growth and generally low inflation. But the structure was starting to unravel. The 1967 devaluation of sterling, the 1968 divorce of the market and official prices of gold, and the 1969 realignments of the French franc and German mark had papered over localized tensions in the Bretton Woods order. At the same time, those events vividly demonstrated that seemingly cherished official commitments could easily succumb to speculative pressures. By March 1973 the Bretton Woods system was history, and dollar exchange rates were floating. In 1970 a majority of academics and policymakers wanted greater exchange rate flexibility. But most, mindful of Ragnar Nurkse's critique of interwar currency practices, did not go so far as to advocatefloating dollar exchange rates. I Typical proposals favored less extreme departures from the existing arrangement: wider fluctuation margins, smaller and

Central Bank Independence, Inflation and Growth in Transition Economies

Abstract: This paper documents two empirical relationships that have emerged as the former communist countries have taken steps to transform their economies. First, data from a sample of twelve transition economies suggest that increased central bank independence (CBI) is correlated with lower inflation rates. This CBI-inflation correlation is not well explained by initial economic conditions and persists after controlling for fiscal performance and the overall quality of economic reforms. Second, across a larger set of twenty-five transition economies, there is a strong and robust negative relationship between inflation and subsequent real GDP growth. Inflation's adverse effect on investment appears to be one significant channel through which the relationship between inflation and growth arises. Copyright 1997 by Ohio State University Press.