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Showing papers on "Inflation published in 2001"


Posted Content
TL;DR: The authors present a model embodying moderate amounts of nominal rigidities which accounts for the observed inertia in inflation and persistence in output, and the key features of their model are those that prevent a sharp rise in marginal costs after an expansionary shock to monetary policy.
Abstract: We present a model embodying moderate amounts of nominal rigidities which accounts for the observed inertia in inflation and persistence in output. The key features of our model are those that prevent a sharp rise in marginal costs after an expansionary shock to monetary policy. Of these features, the most important are staggered wage contracts of average duration three quarters, and variable capital utilization.

2,580 citations


Journal ArticleDOI
TL;DR: This paper examined a model of dynamic price adjustment based on the assumption that information disseminates slowly throughout the population and found that the change in inflation is positively correlated with the level of economic activity.
Abstract: This paper examines a model of dynamic price adjustment based on the assumption that information disseminates slowly throughout the population. Compared to the commonly used sticky-price model, this sticky-information model displays three, related properties that are more consistent with accepted views about the effects of monetary policy. First, disinflations are always contractionary (although announced disinflations are less contractionary than surprise ones). Second, monetary policy shocks have their maximum impact on inflation with a substantial delay. Third, the change in inflation is positively correlated with the level of economic activity.

1,901 citations


Journal ArticleDOI
TL;DR: Di Tella et al. as mentioned in this paper showed that the costs of inflation in terms of unemployment can be measured by the relative size of the weights attached to these variables in social well-being.
Abstract: Modern macroeconomics textbooks rest upon the assumption of a social welfare function defined on inflation, p, and unemployment, U. However, no formal evidence for the existence of such a function has been presented in the literature. Although an optimal policy rule cannot be chosen unless the parameters of the presumed W(p, U) function are known, that has not prevented its use in a large theoretical literature in macroeconomics. This paper has two aims. The first is to show that citizens care about these two variables. We present evidence that inflation and unemployment belong in a well-being function. The second is to calculate the costs of inflation in terms of unemployment. We measure the relative size of the weights attached to these variables in social well-being. Policy implications emerge. Economists have often puzzled over the costs of inflation. Survey evidence presented in Robert J. Shiller (1997) shows that, when asked how they feel about inflation, individuals report a number of unconventional costs, like exploitation, national prestige, and loss of morale. Skeptics wonder. One textbook concludes: “we shall see that standard characterizations of the policy maker’s objective function put more weight on the costs of inflation than is suggested by our understanding of the effects of inflation; in doing so, they probably reflect political realities and the heavy political costs of high inflation” (Blanchard and Fischer, 1989 pp. 567–68). Since reducing inflation is often costly, in terms of extra unemployment, some observers have argued that the industrial democracies’ concern with nominal price stability is excessive—and have urged different monetary policies. This paper proposes a new approach. It examines how survey respondents’ reports of their well-being vary as levels of unemployment and inflation vary. Because the survey responses are available across time and countries, we are able to quantify how self-reported well-being alters with unemployment and inflation rates. Only a few economists have looked at patterns in subjective happiness and life satisfaction. Richard Easterlin (1974) helped to begin the literature. Later contributions include David Morawetz et al. (1977), Robert H. Frank (1985), Ronald Inglehart (1990), Yew-Kwang Ng (1996), Andrew J. Oswald (1997), and Liliana Winkelmann and Rainer Winkelmann (1998). More recently Ng (1997) discusses the measurability of happiness, and Daniel Kahneman et al. (1997) provide an axiomatic defense of experienced utility, and propose applications to economics. Our paper also borders on work in the psychology literature; see, for example, Edward Diener (1984), William Pavot et al. (1991), and David Myers (1993). Section I describes the main data source and the estimation strategy. This relies on a regressionadjusted measure of well-being in a particular year and country—the level not explained by individual personal characteristics. This residual macroeconomic well-being measure is the paper’s focus. * Di Tella: Harvard Business School, Morgan Hall, Soldiers Field, Boston, MA 02163; MacCulloch: STICERD, London School of Economics, London WC2A 2AE, England; Oswald: Department of Economics, University of Warwick, Coventry CV4 7AL, England. For helpful discussions, we thank George Akerlof, Danny Blanchflower, Andrew Clark, Ben Friedman, Duncan Gallie, Sebastian Galiani, Ed Glaeser, Berndt Hayo, Daniel Kahneman, Guillermo Mondino, Steve Nickell, Julio Rotemberg, Hyun Shin, John Whalley, three referees, and seminar participants at Oxford University, Harvard Business School, and the NBER Behavioral Macro Conference in 1998. The third author is grateful to the Leverhulme Trust and the Economic and Social Research Council for research support. 1 See, for example, Olivier Blanchard and Stanley Fischer (1989), Michael Burda and Charles Wyplosz (1993), and Robert E. Hall and John Taylor (1997). Early influential papers include Robert J. Barro and David Gordon (1983). 2 N. Gregory Mankiw (1997) describes the question “How costly is inflation?” as one of the four major unsolved problems of macroeconomics. 3 A recent contribution to this debate in the United States is Paul Krugman’s piece, “Stable Prices and Fast Growth: Just Say No,” The Economist, August 31, 1996.

1,757 citations


Posted Content
TL;DR: The authors examined the predictive performance of asset prices for inflation and real output growth in seven OECD countries for a span of up to 41 years (1959 1999) and concluded that good forecasting performance by an indicator in one period seems to be unrelated to whether it is a useful predictor in a later period.
Abstract: This paper examines old and new evidence on the predictive performance of asset prices for inflation and real output growth. We first review the large literature on this topic, focusing on the past dozen years. We then undertake an empirical analysis of quarterly data on up to 38 candidate indicators (mainly asset prices) for seven OECD countries for a span of up to 41 years (1959 1999). The conclusions from the literature review and the empirical analysis are the same. Some asset prices predict either inflation or output growth in some countries in some periods. Which series predicts what, when and where is, however, itself difficult to predict: good forecasting performance by an indicator in one period seems to be unrelated to whether it is a useful predictor in a later period. Intriguingly, forecasts produced by combining these unstable individual forecasts appear to improve reliably upon univariate benchmarks.

1,432 citations


Posted Content
TL;DR: In this paper, the authors provide evidence on the fit of the New Phillips Curve (NPQ) for the Euro area over the period 1970-1998, and use it as a tool to compare the characteristics of European inflation dynamics with those observed in the U.S. They also analyze the factors underlying inflation inertia by examining the cyclical behavior of marginal costs, as well as that of its two main components.
Abstract: We provide evidence on the fit of the New Phillips Curve (NPQ for the Euro area over the period 1970-1998, and use it as a tool to compare the characteristics of European inflation dynamics with those observed in the U.S. We also analyze the factors underlying inflation inertia by examining the cyclical behavior of marginal costs, as well as that of its two main components, namely, labor productivity and real wages. Some of the findings can be summarized as follows: (a) the NPC fits Euro area data very well, possibly better than U.S. data, (b) the degree of price stickiness implied by the estimates is substantial, but in line with survey evidence and U.S. estimates, (c) inflation dynamics in the Euro area appear to have a stronger forward- looking component (i.e., less inertia) than in the U.S., (d) labor market frictions, as manifested in the behavior of the wage markup, appear to have played a key role in shaping the behavior of marginal costs and, consequently, inflation in Europe.

918 citations


Journal ArticleDOI
TL;DR: The starting point for the economic debate is the thesis that the 1990's are a mirror image of the 1970's, when an unfavorable series of "supply shocks" led to stagflation - slower growth and higher inflation as discussed by the authors.
Abstract: The resurgence of the American economy since 1995 has outrun all but the most optimistic expectations. Economic forecasting models have been seriously off track and growth projections have been revised to reflect a more sanguine outlook only recently. It is not surprising that the unusual combination of more rapid growth and slower inflation in the 1990's has touched off a strenuous debate among economists about whether improvements in America's economic performance can be sustained. The starting point for the economic debate is the thesis that the 1990's are a mirror image of the 1970's, when an unfavorable series of "supply shocks" led to stagflation -- slower growth and higher inflation. In this view, the development of information technology (IT) is one of a series of positive, but temporary, shocks. The competing perspective is that IT has produced a fundamental change in the U.S. economy, leading to a permanent improvement in growth prospects.

840 citations


Journal ArticleDOI
TL;DR: This article used Bayesian methods to account for the four sources of uncertainty in a random coefficients vector autoregression for inflation, unemployment, and an interest rate, and used the model to assemble evidence about the evolution of measures of the persistence of inflation, prospective long-horizon forecasts (means) of inflation and unemployment.
Abstract: For postwar U.S. data, this paper uses Bayesian methods to account for the four sources of uncertainty in a random coefficients vector autoregression for inflation, unemployment, and an interest rate. We use the model to assemble evidence about the evolution of measures of the persistence of inflation, prospective long-horizon forecasts (means) of inflation and unemployment, statistics for testing an approximation to the natural-unemployment-rate hypothesis, and a version of the Taylor rule. We relate these measures to stories that interpret the conquest of U.S. inflation under Volcker and Greenspan as reflecting how the monetary policy authority came to learn an approximate version of the natural-unemployment-rate hypothesis. We study Taylor's warning that defects in that approximation may cause the monetary authority to forget the natural-rate hypothesis as the persistence of inflation attenuates.

786 citations


Journal ArticleDOI
TL;DR: In this paper, the authors consider the Taylor rule in the context of a simple, but widely used, optimizing model of the monetary transmission mechanism, which allows one to reach clear conclusions about economic welfare.
Abstract: where it denotes the Fed’s operating target for the federal funds rate, pt is the inflation rate (measured by the GDP deflator), yt is the log of real GDP, and y# t is the log of potential output (identified empirically with a linear trend). The rule has since been subject to considerable attention, both as an account of actual policy in the United States and elsewhere, and as a prescription for desirable policy. Taylor argues for the rule’s normative significance both on the basis of simulations and on the ground that it describes U.S. policy in a period in which monetary policy is widely judged to have been unusually successful (Taylor, 1999), suggesting that the rule is worth adopting as a principle of behavior. Here I wish to consider to what extent this prescription resembles the sort of policy that economic theory would recommend. I consider the question in the context of a simple, but widely used, optimizing model of the monetary transmission mechanism, which allows one to reach clear conclusions about economic welfare. The model is highly stylized but incorporates important features of more realistic models and allows me to make several points that are of more general validity. Out of concern for the robustness of the conclusions reached, the analysis here addresses only broad, qualitative features of the Taylor rule and attempts to identify features of a desirable policy rule that are likely to hold under a variety of model specifications.

786 citations


Book
01 Jan 2001
TL;DR: This paper examined two broad explanations for the behaviour of inflation and unemployment in this period: the natural-rate hypothesis joined to the Lucas critique and a more traditional econometric policy evaluation modified to include adaptive expectations and learning.
Abstract: Presenting an analysis of the rise and fall of U.S. inflation after 1960, this book examines two broad explanations for the behaviour of inflation and unemployment in this period: the natural-rate hypothesis joined to the Lucas critique and a more traditional econometric policy evaluation modified to include adaptive expectations and learning. The text begins with an explanation of how American policymakers increased inflation in the early 1960s by following erroneous assumptions about the exploitability of the Phillips curve - the inverse-relationship between inflation and unemployment. In subsequent chapters, it connects a sequence of ideas, such as self-confirming equilibria, least-squares and other adaptive or recursive learning algorithms. The author synthesizes results from macroeconomics, game theory, control theory, and other fields to extend both adaptive expectations and rational expectations theory, and he explains postwar inflation in terms of drifting coefficients. He interprets his results in favour of adaptive expectations as the relevant mechanism affecting inflation policy. This book is intended for academics, graduate students, and professional economists.

739 citations


Journal ArticleDOI
TL;DR: It is argued that once the zero bound on nominal interest rates is taken into account, active interest-rate feedback rules can easily lead to unexpected consequences and the use of local techniques for monetary policy evaluation might lead to spurious policy recommendations.

716 citations


Journal ArticleDOI
22 Mar 2001
TL;DR: In this paper, the authors argue that the U.S. economy has experienced a large underlying decline in output volatility over the last twenty years and that this decline is not the byproduct of a "New Economy" or of Alan Greenspan's talent.
Abstract: SINCE THE EARLY 1980S the U.S. economy has gone through two long expansions. The first, from 1982 to 1990, lasted thirty-one quarters. The second started in 1991 and, although showing signs of faltering, has recorded its fortieth quarter as this volume goes to press and is already the longest U.S. expansion on record. One view is that these two long expansions are simply the result of luck, of an absence of major adverse shocks over the last twenty years. We argue that more has been at work, namely, a large underlying decline in output volatility. Furthermore, we contend, this decline is not a recent development--the by-product of a "New Economy" or of Alan Greenspan's talent. Rather it has been a steady decline over several decades, which started in the 1950s (or earlier, but lack of consistent data makes this difficult to establish), was interrupted in the 1970s and early 1980s, and returned to trend in the late 1980s and the 1990s.(1) The magnitude of the decline is substantial: the standard deviation of quarterly output growth has declined by a factor of three over the period. This is more than enough to account for the increased length of expansions. Having established this fact, we reach two other conclusions. First, the decrease in volatility can be traced to a number of proximate causes, from a decrease in the volatility of government spending early on, to a decrease in consumption and investment volatility throughout the period, to a change in the sign of the correlation between inventory investment and sales in the last decade. Second, there is a strong relationship between movements in output volatility and movements in inflation volatility. The interruption of the trend decline in output volatility in the 1970s was associated with a large increase in inflation volatility; the return to trend is associated with the decrease in inflation volatility since then. This paper is organized as follows. We start by documenting our basic fact, namely, the secular decrease in output volatility. We then look at the stochastic process for GDP and show that this decrease in volatility can be traced primarily to a decrease in the standard deviation of output shocks, rather than to a change in the dynamics of output. Finally, we show how this decrease in the standard deviation of shocks accounts for the increased length of expansions. We then take up the question of whether recessions are special, in a way that the formalization used earlier does not do justice to. Put another way, we ask whether what we have seen over the last twenty years is simply the absence of large shocks and nothing more. We show that this is not the case. The measured decrease in output volatility has little to do with the absence of large shocks in the recent past. We then turn to the relationship between output volatility and inflation. We show that there is a strong relationship both between output volatility and the level of inflation, and between output volatility and inflation volatility. Both volatilities went up in the 1970s and have come down since. Correlation does not, however, imply causality. The correlation in both periods may have been due to third factors, such as supply shocks in the 1970s. This leads us to consider evidence from the other members of the Group of Seven (G-7) large industrial countries. Our motivation here is that the different timings of disinflation across these countries can help us separate out the effects of inflation from those of supply shocks. We first show that these other countries have also experienced a decline in output volatility, although with some differences in timing and in magnitude. (An interesting exception is Japan, where a decline in output volatility has been reversed since the late 1980s.) We then show that, even after controlling for common time fixed effects, inflation volatility still appears to be strongly related to output volatility. As a matter of accounting, the decline in output volatility can be traced either to changes in the composition of output or to changes in the variances and covariances of its underlying components. …

Journal ArticleDOI
TL;DR: This paper present a model embodying moderate amounts of nominal rigidities which accounts for the observed inertia in inflation and persistence in output, and the key features of their model are those that prevent a sharp rise in marginal costs after an expansionary shock to monetary policy.
Abstract: We present a model embodying moderate amounts of nominal rigidities which accounts for the observed inertia in inflation and persistence in output. The key features of our model are those that prevent a sharp rise in marginal costs after an expansionary shock to monetary policy. Of these features, the most important are staggered wage contracts of average duration three quarters, and variable capital utilization.

Journal ArticleDOI
TL;DR: In this paper, the authors extended their analysis to the case of a small open economy and showed that under certain conditions, the monetary policy design problem for the small-open economy is isomorphic to the problem of the closed economy that they considered earlier.
Abstract: In Clarida et al. (1999; hereafter CGG), we presented a normative analysis of monetary policy within a simple optimization-based closedeconomy framework. We derived the optimal policy rule and, among other things, characterized the gains from commitment. Also, we made precise the implications for the kind of instrument feedback rule that a central bank should follow in practice. In this paper we show how our analysis extends to the case of a small open economy. Openness complicates the problem of monetary management to the extent the central bank must take into account the impact of the exchange rate on real activity and inflation. How to factor the exchange rate into the overall design of monetary policy accordingly becomes a central consideration. Here we show that, under certain conditions, the monetary-policy design problem for the small open economy is isomorphic to the problem of the closed economy that we considered earlier. Hence, all our qualitative results for the closed economy carry over to this case. Openness does affect the parameters of the model, suggesting quantitative implications. Though the general form of the optimal interest-rate feedback rule remains the same as in the closedeconomy case, for example, how aggressively a central bank should adjust the interest rate in response to inflationary pressures depends on the degree of openness. In addition, openness gives rise to an important distinction between domestic inflation and consumer price inflation (as defined by the CPI). To the extent that there is perfect exchange-rate pass-through, we find that the central bank should target domestic inflation and allow the exchange rate to float, despite the impact of the resulting exchangerate variability on the CPI (Kosuki Aoki, 1999; Gali and Tommaso Monacelli, 2000).

Posted ContentDOI
TL;DR: In this paper, the authors derived a pass-through relation based on new open economy macroeconomic models and found that a low inflationary environment leads to a low exchange rate passthrough to domestic prices.
Abstract: The paper tests a hypothesis suggested by Taylor (2000) that a low inflationary environment leads to a low exchange rate pass-through to domestic prices. To test this hypothesis, the paper derives a pass-through relation based on new open economy macroeconomic models. A large database that includes 1979-2000 data for 71 countries is used to estimate this relation. There is strong evidence of a positive and significant association between the pass-through and the average inflation rate across countries and periods. The inflation rate, moreover, dominates other macroeconomic variables in explaining cross-regime differences in the pass-through.

Journal ArticleDOI
Kosuke Aoki1
TL;DR: In this article, an optimal monetary policy for a small open economy with a flexible price sector and a sticky price sector is presented. But the optimal policy is to target sticky-price inflation, rather than a broad inflation measure.

Journal ArticleDOI
TL;DR: This article developed a theoretical model that attributes the change in the rate of pass-through to increased emphasis on inflation stabilization by many central banks and found widespread evidence of a robust and statistically significant link between estimated rates of passthrough and inflation variability.
Abstract: The pass-through of exchange rate changes into domestic inflation appears to have declined in many countries since the 1980s. We develop a theoretical model that attributes the change in the rate of pass-through to increased emphasis on inflation stabilization by many central banks. This hypothesis is tested on 20 industrial countries between 1971 and 2003. We find widespread evidence of a robust and statistically significant link between estimated rates of pass-through and inflation variability. We also find evidence that observed monetary policy behaviour may be a factor in the declining rate of pass-through. Published in 2004 by John Wiley & Sons, Ltd.

BookDOI
01 Jan 2001
TL;DR: In this article, the authors re-examine the existence of threshold effects in the relationship between inflation and growth, using new econometric techniques that provide appropriate procedures for estimation and inference.
Abstract: This paper re-examines the issue of the existence of threshold effects in the relationship between inflation and growth, using new econometric techniques that provide appropriate procedures for estimation and inference. The threshold level of inflation above which inflation significantly slows growth is estimated at 1-3 percent for industrial countries and 11-12 percent for developing countries. The negative and significant relationship between inflation and growth, for inflation rates above the threshold level, is quite robust with respect to the estimation method, perturbations in the location of the threshold level, the exclusion of high-inflation observations, data frequency, and alternative specifications.

Posted Content
TL;DR: In this article, the fit of the New Phillips Curve (NPC) for the Euro area over the period 1970-1998 was examined. And the authors used it as a tool to compare the characteristics of European inflation dynamics with those observed in the U.S.
Abstract: We provide evidence on the fit of the New Phillips Curve (NPC) for the Euro area over the period 1970–1998, and use it as a tool to compare the characteristics of European inflation dynamics with those observed in the U.S. We also analyse the factors underlying inflation inertia by examining the cyclical behaviour of marginal costs, as well as that of its two main components, namely, labour productivity and real wages. Some of the findings can be summarized as follows: (a) the NPC fits Euro area data very well, possibly better than US data, (b) the degree of price stickiness implied by the estimates is substantial, but in line with survey evidence and US estimates, (c)\ inflation dynamics in the Euro area appear to have a stronger forward-looking component (i.e., less inertia) than in the US, (d) labour market frictions, as manifested in the behaviour of the wage markup, appear to have played a key role in shaping the behaviour of marginal costs and, consequenty, inflation in Europe.

Journal ArticleDOI
TL;DR: The authors discusses the short-run tradeoff between inflation and unemployment and argues that this tradeoff remains a necessary building block of business cycle theory, although economists have yet to provide a completely satisfactory explanation for it according to the consensus view among central bankers and monetary economists.
Abstract: This paper discusses the short-run tradeoff between inflation and unemployment Although this tradeoff remains a necessary building block of business cycle theory, economists have yet to provide a completely satisfactory explanation for it According to the consensus view among central bankers and monetary economists, a contractionary monetary shock raises unemployment, at least temporarily, and leads to a delayed and gradual fall in inflation Standard dynamic models of price adjustment, however, cannot explain this pattern of responses Reconciling the consensus view about the effects of monetary policy with models of price adjustment remains an outstanding puzzle for business cycle theorists Several years ago I gave myself a peculiar assignment: I decided to try to summarise all of economics in ten simply stated principles The purpose of this task was to introduce students to the economic way of thinking in the first chapter of my textbook Principles of Economics I figured if God could boil all of moral philosophy down to ten commandments, I should be able to do much the same with economic science Most of the ten principles I chose were microeconomic and hard to argue with They involved the importance of tradeoffs, marginal analysis, the benefits of trade, market efficiency, market failure, and so on I allocated the last three principles to macroeconomics The first of these was 'A country's standard of living depends on its ability to produce goods and services', which I viewed as the foundation of all growth theory The second was, 'Prices rise when the government prints too much money', which I took to be the essence of classical monetary theory The last of my ten principles is the subject of today's lecture: 'Society faces a short-run tradeoff between inflation and unemployment' Perhaps not surprisingly, this statement turned out to be controversial When my publisher sent out the manuscript for review, a few readers objected

Posted Content
TL;DR: This article showed that an optimization-based DGE model with four-quarter price and wage contracts can generate highly persistent inflation and output responses when the private sector must use signal extraction to make inferences about the central bank's inflation target based on only observing the policy instrument.
Abstract: Contract structures typically embedded in a recent generation of models with nominal inertia have been criticized for a failure to generate persistent responses of output and inflation to nominal shocks. In this paper, we argue that this failure does not reflect an inherent limitation of the contract structure, but rather, very strong assumptions about central bank credibility. We show that an optimization-based DGE model with four-quarter price and wage contracts can generate highly persistent inflation and output responses when the private sector must use signal extraction to make inferences about the central bank's inflation target based on only observing the policy instrument. In particular, we consider the disinflation experiences of the United States and several other industrial countries in the early 1980s, and we demonstrate that the model matches the dynamics of both expected and actual inflation and generates sacrifice ratios which are roughly in line with empirical estimates.

Posted Content
TL;DR: The authors reconsiders the Phelps-Lucas hypothesis, according to which temporary real effects of purely nominal disturbances result from imperfect information, but departs from the assumptions of Lucas (1973) in two crucial respects.
Abstract: This paper reconsiders the Phelps-Lucas hypothesis, according to which temporary real effects of purely nominal disturbances result from imperfect information, but departs from the assumptions of Lucas (1973) in two crucial respects. Due to monopolistically competitive pricing, higher-order expectations are crucial for aggregate inflation dynamics, as argued by Phelps (1983). And decisionmakers' subjective perceptions of current conditions are assumed to be of imperfect precision, owing to finite information processing capacity, as argued by Sims (2001). The model can explain highly persistent real effects of a monetary disturbance, and a delayed effect on inflation, as found in VAR studies.

Journal ArticleDOI
TL;DR: This article reviewed recent research on central bank independence and concluded that the negative relationship between CBI and inflation is quite robust and pointed out various challenges that have been raised against previous empirical findings on CBI.
Abstract: This paper reviews recent research on central bank independence (CBI) After we have distinguished between independence and conservativeness, research in which the inflationary bias is endogenised is reviewed Finally, the various challenges that have been raised against previous empirical findings on CBI are discussed We conclude that the negative relationship between CBI and inflation is quite robust

Journal ArticleDOI
TL;DR: In this paper, the fit of the New Phillips Curve (NPC) for the Euro area over the period 1970-1998, and use it as a tool to compare the characteristics of European inflation dynamics with those observed in the U.S.

Journal ArticleDOI
TL;DR: In this paper, the welfare implications of policy rules when international financial markets are incomplete were evaluated using a two-country dynamic general equilibrium model with incomplete markets, price stickiness and monopolistic competition, and it was shown that an allocation in which the producer inflation rates in both countries are stabilized to zero reproduces the flexible price allocation.
Abstract: This Paper evaluates the welfare implications of policy rules when international financial markets are incomplete. Using a two-country dynamic general equilibrium model with incomplete markets, price stickiness and monopolistic competition, one finds that an allocation in which the producer inflation rates in both countries are stabilized to zero reproduces the flexible-price allocation. This allocation, however, is sub-optimal with deadweight losses evaluated at around 0.05 percent of a permanent shift in steady-state consumption. A state-contingent producer inflation policy is the feasible first-best. The gains from pursuing this policy instead of price stability are, however, small in terms of reduction in the deadweight losses. Therefore, under incomplete markets, price stability is a good approximation of the feasible first best policy.

Journal ArticleDOI
TL;DR: In this article, the authors investigate the performance of forecast-based monetary policy rules using five macroeconomic models that reflect a wide range of views on aggregate dynamics and identify the key characteristics of rules that are robust to model uncertainty.
Abstract: We investigate the performance of forecast-based monetary policy rules using five macroeconomic models that reflect a wide range of views on aggregate dynamics. We identify the key characteristics of rules that are robust to model uncertainty: such rules respond to the one-year ahead inflation forecast and to the current output gap, and incorporate a substantial degree of policy inertia. In contrast, rules with longer forecast horizons are less robust and are prone to generating indeterminacy. In light of these results, we identify a robust benchmark rule that performs very well in all five models over a wide range of policy preferences

Posted Content
TL;DR: In this paper, the authors developed a theoretical model that attributes the change in pass-through (defined as the correlation of inflation with exchange rate changes) to increased emphasis on inflation stabilization by many central banks.
Abstract: Recent research suggests that the pass-through of exchange rate changes into domestic inflation has declined in many countries since the 1980s. We develop a theoretical model that attributes the change in pass-through (defined as the correlation of inflation with exchange rate changes) to increased emphasis on inflation stabilization by many central banks. This hypothesis is tested on eleven industrial countries between 1971 and 2000. We find widespread evidence of both a decline in pass-through and a decline in the variability of inflation in the 1990s. We also find a statistically significant link between measured pass-through and inflation variability. However, our efforts to correlate the decline in pass-through with estimated changes in monetary policy behavior are inconclusive due to poor estimates of policy behavior.

Journal ArticleDOI
TL;DR: The authors used GMM to estimate specifications incorporating both lagged and future inflation, and found that the new-Keynesian pricing model cannot explain the importance of lagged inflation in standard inflation regressions and that forward-looking terms play a very limited role in explaining inflation dynamics.

Journal ArticleDOI
TL;DR: In this paper, the authors estimate a forward-looking monetary policy reaction function for the Federal Reserve for the periods before and after Paul Volcker's appointment as Chairman in 1979, using information that was available to the FOMC in real time from 1966 to 1995.
Abstract: I estimate a forward-looking monetary policy reaction function for the Federal Reserve for the periods before and after Paul Volcker’s appointment as Chairman in 1979, using information that was available to the FOMC in real time from 1966 to 1995. The results suggest broad similarities in policy and point to a forward-looking approach to policy consistent with a strong reaction to inflation forecasts during both periods. This contradicts the hypothesis, based on analysis with ex post constructed data, that the instability of the Great Inflation was the result of weak FOMC policy responses to expected inflation. A difference is that prior to Volcker’s appointment, policy was too activist in reacting to perceived output gaps that retrospectively proved overambitious. Drawing on contemporaneous accounts of FOMC policy, I discuss the implications of the findings for alternative explanations of the Great Inflation and the improvement in macroeconomic stability since then.

Posted Content
TL;DR: This article proposed an alternative approach for constructing such models by treating imports not as finished consumer goods but rather as raw-material inputs to the home economy's productive process, which leads to a clean and simple theoretical structure that has some empirical attractions as well.
Abstract: The ‘new open-economy macroeconomics’ seeks to provide an improved basis for monetary and exchange-rate policy through the construction of open-economy models that feature rational expectations, optimising agents, and slowly adjusting prices of goods. This paper promotes an alternative approach for constructing such models by treating imports not as finished consumer goods but rather as raw-material inputs to the home economy’s productive process. This treatment leads to a clean and simple theoretical structure that has some empirical attractions as well. A particular smalleconomy model is calibrated and its properties exhibited, primarily by means of impulse response functions. The preferred variant is shown to feature a pattern of correlations between exchange-rate changes and inflation that is more realistic than provided by a more standard specification. Important recent events are interpreted in light of the alternative models.

Journal ArticleDOI
TL;DR: In this article, the relationship between inflation, output, money and interest rates in the euro area, using data spanning 1980-2000, has been studied, and it was shown that the real money gap contains more information about future inflation than the output gap and the Eurosystem's money growth indicator.
Abstract: This paper studies the relationship between inflation, output, money and interest rates in the euro area, using data spanning 1980-2000. The P model is shown to have considerable empirical support. Thus, the "price gap" or, equivalently, the "real money gap" (the gap between current real balances and long-run equilibrium real balances), has substantial predictive power for future inflation. The real money gap contains more information about future inflation than the output gap and the Eurosystem's money-growth indicator (the gap between current M3 growth and a reference value). The results suggest that the Eurosystem's money-growth indicator is an inferior indicator of future inflation.