Showing papers on "Inflation published in 2008"

Five Facts about Prices: A Reevaluation of Menu Cost Models

Abstract: are price decreases. (3) The frequency of price increases covaries strongly with inflation, whereas the frequency of price decreases and the size of price increases and price decreases do not. (4) The frequency of price change is highly seasonal: it is highest in the first quarter and then declines. (5) We find no evidence of upwardsloping hazard functions of price changes for individual products. We show that the first, second, and third facts are consistent with a benchmark menu-cost model, whereas the fourth and fifth facts are not.

Monetary policy, inflation, and the business cycle : an introduction to the new Keynesian framework

Abstract: The New Keynesian framework has emerged as the workhorse for the analysis of monetary policy and its implications for inflation, economic fluctuations, and welfare. It is the backbone of the new generation of medium-scale models under development at major central banks and international policy institutions, and provides the theoretical underpinnings of the inflation stability-oriented strategies adopted by most central banks throughout the industrialized world. This graduate-level textbook provides an introduction to the New Keynesian framework and its applications to monetary policy. Using a canonical version of the New Keynesian model as a reference framework, Jordi Gali explores issues pertaining to the design of monetary policy, including the determination of the optimal monetary policy and the desirability of simple policy rules. He analyzes several extensions of the baseline model, allowing for cost-push shocks, nominal wage rigidities, and open economy factors. In each case, the implications for monetary policy are addressed, with a special emphasis on the desirability of inflation targeting policies. The most up-to-date and accessible introduction to the New Keynesian framework available Uses a single benchmark model throughout Concise and easy to use Includes exercises An ideal resource for graduate students, researchers, and market analysts

The Economic Effects of Energy Price Shocks

Abstract: Large fluctuations in energy prices have been a distinguishing characteristic of the U.S. economy since the 1970s. Turmoil in the Middle East, rising energy prices in the U.S. and evidence of global warming recently have reignited interest in the link between energy prices and economic performance. This paper addresses a number of the key issues in this debate: What are energy price shocks and where do they come from? How responsive is energy demand to changes in energy prices? How do consumers’ expenditure patterns evolve in response to energy price shocks? How do energy price shocks affect U.S. real output, inflation and stock prices? Why do energy price increases seem to cause recessions, but energy price decreases do not seem to cause expansions? Why has there been a surge in the price of oil in recent years? Why has this new energy price shock not caused a recession so far? Have the effects of energy price shocks waned since the 1980s and, if so, why? As the paper demonstrates, it is critical to account for the endogeneity of energy prices and to differentiate between the effects of demand and supply shocks in energy markets, when answering these questions.

The Spline-GARCH Model for Low Frequency Volatility and its Global Macroeconomic Causes

Abstract: Twenty-five years of volatility research has left the macroeconomic environment playing a minor role. This paper proposes modeling equity volatilities as a combination of macro- economic effects and time series dynamics. High-frequency return volatility is specified to be the product of a slow-moving component, represented by an exponential spline, and a unit GARCH. This slow-moving component is the low-frequency volatility, which in this model coincides with the unconditional volatility. This component is estimated for nearly 50 countries over various sample periods of daily data. Low-frequency volatility is then modeled as a function of macroeconomic and financial variables in an unbalanced panel with a variety of dependence structures. It is found to vary over time and across countries. The low-frequency component of volatility is greater when the macroeconomic factors of GDP, inflation, and short-term interest rates are more volatile or when inflation is high and output growth is low. Volatility is higher not only for emerging markets and markets with small numbers of listed companies and market capitalization relative to GDP, but also for large economies. The model allows long horizon forecasts of volatility to depend on macroeconomic developments, and delivers estimates of the volatility to be anticipated in a newly opened market.

Credit Frictions and Optimal Monetary Policy

Abstract: We extend the basic (representative-household) New Keynesian [NK] model of the monetary transmission mechanism to allow for a spread between the interest rate available to savers and borrowers, that can vary for either exogenous or endogenous reasons. We find that the mere existence of a positive average spread makes little quantitative difference for the predicted effects of particular policies. Variation in spreads over time is of greater significance, with consequences both for the equilibrium relation between the policy rate and aggregate expenditure and for the relation between real activity and inflation. Nonetheless, we find that the target criterion - a linear relation that should be maintained between the inflation rate and changes in the output gap - that characterizes optimal policy in the basic NK model continues to provide a good approximation to optimal policy, even in the presence of variations in credit spreads. We also consider a "spread-adjusted Taylor rule," in which the intercept of the Taylor rule is adjusted in proportion to changes in credit spreads. We show that while such an adjustment can improve upon an unadjusted Taylor rule, the optimal degree of adjustment is less than 100 percent; and even with the correct size of adjustment, such a rule of thumb remains inferior to the targeting rule.

Trend Inflation, Indexation, and Inflation Persistence in the New Keynesian Phillips Curve

Abstract: Purely forward-looking versions of the New Keynesian Phillips curve (NKPC) generate too little inflation persistence. Some authors add ad hoc backward looking terms to address this shortcoming. We hypothesize that inflation per? sistence results mainly from variation in the long-run trend component of inflation, which we attribute to shifts in monetary policy. We derive a version of the NKPC that incorporates a time-varying inflation trend and examine whether it explains the dynamics of inflation. When drift in trend inflation is taken into account, a purely forward-looking version of the model fits the data well, and there is no need for backward-looking components. (JEL E12, E31, E52) In this paper we consider the extent to which Guillermo Calvo's (1983) model of nominal price rigidities can explain inflation dynamics without relying on arbitrary backward-looking terms. In its baseline formulation, the Calvo model leads to a purely forward-looking New Keynesian

State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?

Abstract: In the 1988-2004 micro data collected by the U.S. Bureau of Labor Statistics for the CPI, price changes are frequent (every 4-7 months, depending on the treatment of sale prices) and large in absolute value (on the order of 10%). The size and timing of price changes varies considerably for a given item, but the size and probability of a price change are unrelated to the time since the last price change. Movements in aggregate inflation reflect movements in the size of price changes rather than the fraction of items changing price, due to offsetting movements in the fraction of price increases and decreases. Neither leading time-dependent models (Taylor or Calvo) nor 1 st generation state-dependent models match all of these facts. Some 2 nd generation state-dependent models, however, appear broadly consistent with the empirical patterns.

Term Premia and Inflation Uncertainty: Empirical Evidence from an International Panel Dataset

Abstract: This paper provides cross-country empirical evidence on bond risk premia. I construct a panel of zero-coupon nominal government bond yields spanning ten industrialized countries and nearly two decades. I hence compute forward rates and then use two different methods to decompose these forward rates into expected future short-term interest rates and term premiums. The first method uses an affine term structure model with macroeconomic variables as unspanned risk factors; the second method uses surveys. I find that term premium estimates declined across countries over the sample period, especially in countries that appear to have reduced inflation uncertainty by making substantial changes in the monetary policy frameworks of their central banks. During the recent financial crisis, term premiums have remained flat and even declined further in some countries, perhaps reflecting the effects of quantitative easing actions by many central banks.

Inflation-Gap Persistence in the U.S

Abstract: We use Bayesian methods to estimate two models of post WWII US inflation rates with drifting stochastic volatility and drifting coefficients One model is univariate, the other a multivariate autoregression We define the inflation gap as the deviation of inflation from a pure random walk component of inflation and use both of our models to study changes over time in the persistence of the inflation gap measured in terms of short- to medium-term predicability We present evidence that our measure of the inflation-gap persistence increased until Volcker brought mean inflation down in the early 1980s and that it then fell during the chairmanships of Volcker and Greenspan Stronger evidence for movements in inflation gap persistence emerges from the VAR than from the univariate model We interpret these changes in terms of a simple dynamic new Keynesian model that allows us to distinguish altered monetary policy rules and altered private sector parameters

Labor Markets and Monetary Policy: A New-Keynesian Model with Unemployment

Abstract: We construct a utility-based model of fluctuations, with nominal rigidities and unemployment, and draw its implications for the unemployment-inflation tradeoff and for the conduct of monetary policy.We proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in unemployment. We show the role of labor market frictions and real wage rigidities in determining the effects of productivity shocks on unemployment.We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of labor market frictions and real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and its dependence on labor market characteristics. We draw the implications for optimal monetary policy.

A comparison of the effects of exogenous oil supply shocks on output and inflation in the G7 countries

Abstract: A comparison of the effects of exogenous shocks to global crude oil production on seven major industrialized economies suggests a fair degree of similarity in the real growth responses. An exogenous oil supply disruption typically causes a temporary reduction in real GDP growth that is concentrated in the second year after the shock. Inflation responses are more varied. The median CPI inflation response peaks after three to four quarters. Exogenous oil supply disruptions need not generate sustained inflation or stagflation. Typical responses include a fall in the real wage, higher short-term interest rates, and a depreciating currency with respect to the dollar. Despite many qualitative similarities, there is strong statistical evidence that the responses to exogenous oil supply disruptions differ across G7 countries. For suitable subsets of countries, homogeneity cannot be ruled out. A counterfactual historical exercise suggests that the evolution of CPI inflation in the G7 countries would have been similar overall to the actual path even in the absence of exogenous shocks to oil production, consistent with a monetary explanation of the inflation of the 1970s. There is no evidence that the 1973–1974 and 2002–2003 oil supply shocks had a substantial impact on real growth in any G7 country, whereas the 1978–1979, 1980, and 1990–1991 shocks contributed to lower growth in at least some G7 countries. (JEL: E31, E32, Q43)

Phillips Curve Inflation Forecasts

Abstract: This paper surveys the literature since 1993 on pseudo out-of-sample evaluation of inflation forecasts in the United States and conducts an extensive empirical analysis that recapitulates and clarifies this literature using a consistent data set and methodology. The literature review and empirical results are gloomy and indicate that Phillips curve forecasts (broadly interpreted as forecasts using an activity variable) are better than other multivariate forecasts, but their performance is episodic, sometimes better than and sometimes worse than a good (not naive) univariate benchmark. We provide some preliminary evidence characterizing successful forecasting episodes.

The Effects of Fiscal Policy in Italy: Evidence from a VAR Model

Abstract: This paper studies the effects of fiscal policy on private GDP, inflation and the long-term interest rate in Italy using a structural vector autoregression model. To this end, a database of quarterly cash data for selected fiscal variables for the period 1982:1-2004:4 is constructed, largely relying on the information contained in the Italian Treasury Quarterly Reports. The main results of the study can be summarized as follows. A shock to government purchases of goods and services has a sizeable and robust effect on economic activity: an exogenous one per cent (in terms of private GDP) shock increases private real GDP by 0.6 per cent after 3 quarters. The response goes to zero after two years, reflecting with a lag the low persistence of the shock. The effects on employment, private consumption and investment are also positive. The response of inflation is positive but small and short-lived. In contrast, public wages, which in many studies are lumped together with purchases, have no significant effect on output, while the effects on employment turn negative after two quarters. Shocks to net revenue have negligible effects on all the variables.

The Term Structure of Real Rates and Expected Inflation

Abstract: Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, time-varying prices of risk, and inflation to identify these components of the nominal yield curve. We find that the unconditional real rate curve in the United States is fairly flat around 1.3%. In one real rate regime, the real term structure is steeply downward sloping. An inflation risk premium that increases with maturity fully accounts for the generally upward sloping nominal term structure. THE REAL INTEREST RATE AND EXPECTED INFLATION are two key economic variables; yet, their dynamic behavior is essentially unobserved. A large empirical literature has yielded surprisingly few generally accepted stylized facts. For example, while theoretical research often assumes that the real interest rate is constant, empirical estimates for the real interest rate process vary between constancy as in Fama (1975), mean-reverting behavior (Hamilton (1985)), or a unit root process (Rose (1988)). There seems to be more consensus on the fact that real rate variation, if it exists at all, should only affect the short end of the term structure whereas the variation in long-term interest rates is primarily affected by shocks to expected inflation (see, among others, Fama (1990) and Mishkin

What's Behind 'Inflation Perceptions'? A Survey-Based Analysis of Italian Consumers

Abstract: This study investigates inflation perceptions in both qualitative and quantitative terms and their relationship with factors likely to affect them. This has been done in a unified framework through a survey of a representative sample of Italian consumers carried out at the end of 2006. The results show that reported inflation is, on average, much higher than measured by official statistics. Inflation perceptions are higher for women, the unemployed and less educated individuals, as well as for consumers with some forms of financial distress. A very low knowledge of the inflation concept and related statistics and an inaccurate memory of past prices turn out to play a significant role in explaining the highest class of perceptions. In contrast, the characteristics of individual shopping activity do not result to be significant. All in all, these results suggest that when consumers express their opinions on what they report as "inflation", they are incorporating a complex combination of forces that go well beyond the phenomena measured by official inflation statistics.

Investigating Inflation Persistence Across Monetary Regimes

Abstract: Under inflation, targeting estimates of the indexation parameter in hybrid New Keynesian Phillips curves are either equal to zero, or very low, in the United Kingdom, Canada, Sweden, and New Zealand. Analogous results hold for the Euro area under the European Monetary Union, and for Switzerland under the new monetary regime: under stable regimes with clearly defined nominal anchors, inflation appears to be purely forward-looking. These results question the notion that the intrinsic inflation persistence found in post-WWII U.S. data is structural in the sense of Lucas (Carnegie-Rochester Conference Series on Public Policy, 1 [1976], 19–46), and suggest that "hardwiring" inflation persistence in macroeconomic models is potentially misleading.

Labour Markets and Monetary Policy: A New Keynesian Model with Unemployment

Abstract: We construct a utility-based model of fluctuations, with nominal rigidities and unemployment, and draw its implications for the unemployment-inflation trade-off and for the conduct of monetary policy. We proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in unemployment. We show the role of labour market frictions and real wage rigidities in determining the effects of productivity shocks on unemployment. We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of labour market frictions and real wage rigidities. We show the nature of the trade-off between inflation and unemployment stabilization, and its dependence on labour market characteristics. We draw the implications for optimal monetary policy.

Great Expectations and the End of the Depression

Abstract: What ended the Great Depression in the United States? This paper suggests that the recovery was driven by a shift in expectations. This shift was triggered by President Franklin Delano Roosevelt’s (FDR) policy actions. On the monetary policy side, Roosevelt abolished the gold standard and announced an explicit policy objective of inflating the price level to pre-Depression levels. On the fiscal policy side, Roosevelt expanded real and deficit spending which helped make his policy objective credible . The key to the recovery was the successful management of expecta tions about future policy . Roosevelt’s rise to power is modeled as a policy regime change , as in Thomas Sargent (1983) and Peter Temin and Barry Wigmore (1990). This paper formalizes Temin and Wigmore’s argu ment in a repeated game setting using a dynamic stochastic general equilibrium (DSGE) model and argues that the regime change can account for the recovery. In the model, a regime change means the elimination of certain “policy dogmas” that constrain the actions of the government. The regime change generates an endogenous shift in expectations due to a coordination of mon etary and fiscal policy. This coordination ended the Great Depression by engineering a shift in expectations from “contractionary” (i.e., the private sector expected future economic contrac tion and deflation) to “expansionary” (i.e., the public expected future economic expansion and inflation). The expectation of higher future inflation lowered real interest rates, thus stimulating demand, while the expectation of higher future income stimulated demand by raising permanent income.

The “Great Moderation” in the United Kingdom

Abstract: We use a Bayesian time-varying parameters structural VAR with stochastic volatility for GDP deflator inflation, real GDP growth, a 3-month nominal rate, and the rate of growth of M4 to investigate the underlying causes of the Great Moderation in the United Kingdom. Our evidence points toward a dominant role played by good luck in fostering the more stable macroeconomic environment of the last two decades. Results from counterfactual simulations, in particular, show that (i) “bringing the Monetary Policy Committee back in time” would only have had a limited impact on the Great Inflation episode, at the cost of lower output growth; (ii) imposing the 1970s monetary rule over the entire sample period would have made almost no difference in terms of inflation and output growth outcomes; and (iii) the Great Inflation was due, to a dominant extent, to large demand non-policy shocks, and to a lesser extent—especially in 1973 and 1979—to supply shocks.

Are Long-Run Inflation Expectations Anchored More Firmly in the Euro Area Than in the United States?

Abstract: This paper compares the evolution of long-run inflation expectations in the euro area and the United States, using evidence from financial markets and surveys of professional forecasters. Survey data indicate that long-run inflation expectations are reasonably well anchored in both economies but reveal substantially greater dispersion across forecasters' long-horizon projections of US inflation. Analysis of daily data on inflation swaps and nominal-indexed bond spreads, which gauge compensation for expected inflation and inflation risk, also suggests that long-run inflation expectations are more firmly anchored in the euro area than in the United States. (JEL D84, E31,

Warm Inflation and its Microphysical Basis

Abstract: The microscopic quantum field theory origins of warm inflation dynamics are reviewed. The warm inflation scenario is first described along with its results, predictions and comparison with the standard cold inflation scenario. The basics of thermal field theory required in the study of warm inflation are discussed. Quantum field theory real time calculations at finite temperature are then presented and the derivation of dissipation and stochastic fluctuations are shown from a general perspective. Specific results are given of dissipation coefficients for a variety of quantum field theory interaction structures relevant to warm inflation, in a form that can readily be used by model builders. Different particle physics models realising warm inflation are presented along with their observational predictions.

The Term Structure of Inflation Expectations

Abstract: We use evidence from the term structure of inflation expectations implicit in the nominal yields and survey forecasts of inflation to address the question of whether or not monetary policy is effective. We construct a model that accommodates forecasts over multiple horizons from multiple surveys and Treasury yields by allowing for differences between risk-neutral, subjective, and objective probability measures. We extract private sector expectations of inflation from this model and establish that they are driven by inflation, real activity and one latent factor, which is correlated with survey forecasts. We show that the interest rate responds to this "survey" factor. The inflation premium and out-of-sample estimates of the inflation long-run mean and persistence suggest that monetary policy became effective over time. As an implication, our model outperforms a standard macro-finance model in inflation and yield forecasting.

Identification of New Keynesian Phillips Curves from a Global Perspective

Abstract: New Keynesian Phillips Curves (NKPC) have been extensively used in the analysis of monetary policy, but yet there are a number of issues of concern about how they are estimated and then related to the underlying macroeconomic theory. The first is whether such equations are identified. To check identification requires specifying the process for the forcing variables (typically the output gap) and solving the model for inflation in terms of the observables. In practice, the equation is estimated by GMM, relying on statistical criteria to choose instruments. This may result in failure of identification or weak instruments. Secondly, the NKPC is usually derived as a part of a DSGE model, solved by log-linearising around a steady state and the variables are then measured in terms of deviations from the steady state. In practice the steady states, e.g. for output, are usually estimated by some statistical procedure such as the Hodrick-Prescott (HP) filter that might not be appropriate. Thirdly, there are arguments that other variables, e.g.interest rates, foreign inflation and foreign output gaps should enter the Phillips curve. This paper examines these three issues and argues that all three benefit from a global perspective. The global perspective provides additional instruments to alleviate the weak instrument problem, yields a theoretically consistent measure of the steady state and provides a natural route for foreign inflation or output gap to enter the NKPC.

The TIPS yield curve and inflation compensation

Abstract: For over ten years, the U.S. Treasury has issued index-linked debt. Federal Reserve Board staff have fitted a yield curve to these indexed securities at the daily frequency from the start of 1999 to the present. This paper describes the methodology that is used and makes the estimates public. Comparison with the corresponding nominal yield curve allows measures of inflation compensation (or breakeven inflation rates) to be computed. We discuss the interpretation of inflation compensation and its relationship to inflation expectations and uncertainty, offering some empirical evidence that these measures are affected by an inflation risk premium that varies considerably at high frequency. In addition, we also find evidence that inflation compensation was held down in the early years of the sample by a premium associated with the illiquidity of TIPS at the time. We hope that the TIPS yield curve and inflation compensation data, which are posted here and will be updated periodically, will provide a useful tool to applied economists.