Showing papers on "Inflation published in 2010"

Growth in a time of debt

Abstract: We study economic growth and inflation at different levels of government and external debt. Our analysis is based on new data on forty-four countries spanning about two hundred years. The dataset incorporates over 3,700 annual observations covering a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances. Our main findings are: First, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more. We find that the threshold for public debt is similar in advanced and emerging economies. Second, emerging markets face lower thresholds for external debt (public and private)--which is usually denominated in a foreign currency. When external debt reaches 60 percent of GDP, annual growth declines by about two percent; for higher levels, growth rates are roughly cut in half. Third, there is no apparent contemporaneous link between inflation and public debt levels for the advanced countries as a group (some countries, such as the United States, have experienced higher inflation when debt/GDP is high.) The story is entirely different for emerging markets, where inflation rises sharply as debt increases.

Financial Literacy among the Young

Abstract: We examined financial literacy among the young using the most recent wave of the 1997 National Longitudinal Survey of Youth. We showed that financial literacy is low; fewer than one-third of young adults possess basic knowledge of interest rates, inflation and risk diversification. Financial literacy was strongly related to sociodemographic characteristics and family financial sophistication. Specifically, a college-educated male whose parents had stocks and retirement savings was about 45 percentage points more likely to know about risk diversification than a female with less than a high school education whose parents were not wealthy.

Primordial Non-Gaussianities from Inflation Models

Abstract: This is a pedagogical review on primordial non-Gaussianities from inflation models. We introduce formalisms and techniques that are used to compute such quantities. We review different mechanisms which can generate observable large non-Gaussianities during inflation, and distinctive signatures they leave on the non-Gaussian profiles. They are potentially powerful probes to the dynamics of inflation. We also provide a nontechnical and qualitative summary of the main results and underlying physics.

Primordial Non-Gaussianities from Inflation Models

Abstract: This is a pedagogical review on primordial non-Gaussianities from inflation models. We introduce formalisms and techniques that are used to compute such quantities. We review different mechanisms which can generate observable large non-Gaussianities during inflation, and distinctive signatures they leave on the non-Gaussian profiles. They are potentially powerful probes to the dynamics of inflation. We also provide a non-technical and qualitative summary of the main results and underlying physics.

Product Creation and Destruction: Evidence and Price Implications

Abstract: This paper describes the extent of product creation and destruction in a large sector of the US economy. We find four times more entry and exit in product markets than is found in labor markets because most product turnover happens within firms. Net product creation is strongly procyclical and primarily driven by creation rather than destruction. We find that a cost-of-living index that takes product turnover into account is 0.8 percentage points per year lower than a “fixed goods” price index like the CPI. The procyclicality of the bias implies that business cycles are more volatile than indicated by official statis tics. (JEL E31, E32, L11, O31)

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. We first show that under a standard utility specification, productivity shocks have no effect on unemploy - ment in the constrained efficient allocation. That property is also shown to hold, despite labor market frictions, in the decentralized equilibrium under flexible prices and wages. Inefficient unemploy - ment fluctuations arise when we introduce real-wage rigidities. As a result, in the presence of staggered price setting by firms, the central bank faces a trade-off between inflation and unemployment stabili - zation, which depends on labor market characteristics. We draw the implications for optimal monetary policy. ( JEL E12, E24, E52)

Inflation-Gap Persistence in the US

Abstract: We estimate vector autoregressions with drifting coefficients and stochastic volatility to investigate whether US inflation persistence has changed. We focus on the inflation gap, defined as the difference between inflation and trend inflation, and we measure persistence in terms of short- to medium-term predictability. We present evidence that inflation-gap persistence increased during the Great Inflation and that it fell after the Volcker disinflation. We interpret these changes using a dynamic new Keynesian model that highlights the importance of changes in the central bank's inflation target. (JEL E12, E31, E52, E58)

How Has the Monetary Transmission Mechanism Evolved Over Time

Abstract: We discuss the evolution in macroeconomic thought on the monetary policy transmission mechanism and present related empirical evidence. The core channels of policy transmission - the neoclassical links between short-term policy interest rates, other asset prices such as long-term interest rates, equity prices, and the exchange rate, and the consequent effects on household and business demand - have remained steady from early policy-oriented models (like the Penn-MIT-SSRC MPS model) to modern dynamic-stochastic-general-equilibrium (DSGE) models. In contrast, non-neoclassical channels, such as credit-based channels, have remained outside the core models. In conjunction with this evolution in theory and modeling, there have been notable changes in policy behavior (with policy more focused on price stability) and in the reduced form correlations of policy interest rates with activity in the United States. Regulatory effects on credit provision have also changed significantly. As a result, we review the empirical evidence on the changes in the effect of monetary policy actions on real activity and inflation and present new evidence, using both a relatively unrestricted factor-augmented vector autoregression (FAVAR) and a DSGE model. Both approaches yield similar results: Monetary policy innovations have a more muted effect on real activity and inflation in recent decades as compared to the effects before 1980. Our analysis suggests that these shifts are accounted for by changes in policy behavior and the effect of these changes on expectations, leaving little role for changes in underlying private-sector behavior (outside shifts related to monetary policy changes).

Currency Choice and Exchange Rate Pass-Through

Abstract: In the open economy macro literature with nominal rigidities, the currency in which goods are priced has important implications for optimal monetary and exchange rate policy and for exchange rate pass-through. We show, using novel data on currency and prices for U.S. imports, that even conditional on a price change, there is a large difierence in the pass-through of the average good priced in dollars (25%) versus non-dollars (95%). We document this to be the case across countries and within disaggregated sectors. This flnding contradicts the assumption in an important class of models that the currency of pricing is exogenous. We present a model of endogenous currency choice in a dynamic price setting environment and show that the predictions of the model are strongly supported by the data.

Short Sellers and Financial Misconduct

Abstract: We examine whether short sellers detect firms that misrepresent their financial statements, and whether their trading conveys external costs or benefits to other investors. Abnormal short interest increases steadily in the 19 months before the misrepresentation is publicly revealed, particularly when the misconduct is severe. Short selling is associated with a faster time-to-discovery, and it dampens the share price inflation that occurs when firms misstate their earnings. These results indicate that short sellers anticipate the eventual discovery and severity of financial misconduct. They also convey external benefits, helping to uncover misconduct and keeping prices closer to fundamental values.

Optimal monetary policy in open economies

Abstract: This chapter studies optimal monetary stabilization policy in interdependent open economies, by proposing a unified analytical framework systematizing the existing literature. In the model, the combination of complete exchange-rate pass-through ('producer currency pricing') and frictionless asset markets ensuring efficient risk sharing, results in a form of open-economy 'divine coincidence': in line with the prescriptions in the baseline New-Keynesian setting, the optimal monetary policy under cooperation is characterized by exclusively inward-looking targeting rules in domestic output gaps and GDP-deflator inflation. The chapter then examines deviations from this benchmark, when cross-country strategic policy interactions, incomplete exchange-rate pass-through ('local currency pricing') and asset market imperfections are accounted for. Namely, failure to internalize international monetary spillovers results in attempts to manipulate international relative prices to raise national welfare, causing inefficient real exchange rate fluctuations. Local currency pricing and incomplete asset markets (preventing efficient risk sharing) shift the focus of monetary stabilization to redressing domestic as well as external distortions: the targeting rules characterizing the optimal policy are not only in domestic output gaps and inflation, but also in misalignments in the terms of trade and real exchange rates, and cross-country demand imbalances.

Inflation Expectations and Risk Premiums in an Arbitrage-Free Model of Nominal and Real Bond Yields †

Abstract: Differences between yields on comparable-maturity U.S. Treasury nominal and real debt, the so-called breakeven inflation (BEI) rates, are widely used indicators of inflation expectations. However, better measures of inflation expectations could be obtained by subtracting inflation risk premiums from the BEI rates. We provide such decompositions using an estimated affine arbitrage-free model of the term structure that captures the pricing of both nominal and real Treasury securities. Our empirical results suggest that long-term inflation expectations have been well anchored over the past few years, and inflation risk premiums, although volatile, have been close to zero on average.

Modeling Inflation after the Crisis

Abstract: In the United States, the rate of price inflation falls in recessions. Turning this observation into a useful inflation forecasting equation is difficult because of multiple sources of time variation in the inflation process, including changes in Fed policy and credibility. We propose a tightly parameterized model in which the deviation of inflation from a stochastic trend (which we interpret as long-term expected inflation) reacts stably to a new gap measure, which we call the unemployment recession gap. The short-term response of inflation to an increase in this gap is stable, but the long-term response depends on the resilience, or anchoring, of trend inflation. Dynamic simulations (given the path of unemployment) match the paths of inflation during post-1960 downturns, including the current one.

Real Time Forecasts of Inflation: The Role of Financial Variables

Abstract: We present a mixed-frequency model for daily forecasts of euro area inflation. The model combines a monthly index of core inflation with daily data from financial markets; estimates are carried out with the MIDAS regression approach. The forecasting ability of the model in real-time is compared with that of standard VARs and of daily quotes of economic derivatives on euro area inflation. We find that the inclusion of daily variables helps to reduce forecast errors with respect to models that consider only monthly variables. The mixed-frequency model also displays superior predictive performance with respect to forecasts solely based on economic derivatives.

A Practical Guide to Public Debt Dynamics, Fiscal Sustainability, and Cyclical Adjustment of Budgetary Aggregates

Abstract: This paper presents a practical guide to public debt dynamics, fiscal sustainability, and cyclical adjustment of budgetary aggregates. The paper discusses fiscal formulas, which may be of practical use in fiscal analysis. The paper derives, respectively, the formulas for debt dynamics, and cyclical and inflation adjustment of budgetary aggregates. It discusses other relationships for special applications, and some practical implications and usage. The formulas related to debt dynamics are based on the assumption that changes in liabilities are the result of above-the-line budgetary operations.

Inflation Risk Premia and Survey Evidence on Macroeconomic Uncertainty

Abstract: The difference between nominal and real interest rates (break-even inflation) is often used to gauge the market's inflation expectations - and has become an important tool in monetary policy analysis. However, break-even inflation can move in response to shifts in inflation risk premia and liquidity premia as well as to changes in expected inflation. This paper sheds light on this issue by analysing the evolution of US break-even inflation from 1997 to mid-2008. Regression results show that survey data on inflation uncertainty and proxies for liquidity premia are important factors.

New Monetarist Economics: Models

Abstract: The purpose of this paper is to discuss some of the models used in New Monetarist Economics, which is our label for a body of recent work on money, banking, payments systems, asset markets, and related topics. A key principle in New Monetarism is that solid microfoundations are critical for understanding monetary issues. We survey recent papers on monetary theory, showing how they build on common foundations. We then lay out a tractable benchmark version of the model that allows us to address a variety of issues. We use it to analyze some classic economic topics, like the welfare effects of inflation, the relationship between money and capital accumulation, and the Phillips curve. We also extend the benchmark model in new ways, and show how it can be used to generate new insights in the study of payments, banking, and asset markets.

Optimal Monetary Policy in an Operational Medium-Sized DSGE Model

Abstract: We show how to construct optimal policy projections in Ramses, the Riksbank’s openeconomy medium-sized DSGE model for forecasting and policy analysis. Bayesian estimation of the parameters of the model indicates that they are relatively invariant to alternative policy assumptions and supports that the model may be regarded as structural in a stable low inflation environment. Past policy of the Riksbank until 2007:3 (the end of the sample used) is better explained as following a simple instrument rule than as optimal policy under commitment. We show and discuss the differences between policy projections for the estimated instrument rule and for optimal policy under commitment, under alternative definitions of the output gap, different initial values of the Lagrange multipliers representing policy in a timeless perspective, and different weights in the central-bank loss function.

Does Inflation Targeting Affect the Dispersion of Inflation Expectations

Abstract: In this paper, we examine the effect of having an inflation targeting framework on the dispersion of inflation forecasts from professional forecasters. We use a panel data set of 25 countries—including 14 inflation targeters—with 16 years of monthly information. We find that the dispersion of long-run inflation expectations is smaller in targeting regimes after controlling for country-specific effects, time-specific effects, the level and the variance of inflation, disinflation periods, and global inflation. On average, the full effect is not observed until the third year after implementation of inflation targeting. When we differentiate between developed and developing countries, the dispersion of inflation expectations after inflation targeting is smaller and statistically significant only in developing countries.

Expectations of Inflation: The Role of Demographic Variables, Expectation Formation, and Financial Literacy

Abstract: When financial decisions have consequences beyond the immediate future, individuals' economic success may depend on their ability to forecast the rate of inflation. Higher inflation expectations have been reported by individuals who are female, poorer, single and less educated. Our results suggest that these demographic differences in inflation expectations may be partially explained by variations in expectation formation and financial literacy. Specifically, higher inflation expectations were reported by individuals who focused more on how to cover their future expenses and on prices they pay (rather than on the US inflation rate) and by individuals with lower financial literacy.

The Macroeconomic Costs and Benefits of the EMU and Other Monetary Unions: An Overview of Recent Research

Abstract: This article provides an overview of recent research into the macroeconomic costs and benefits of monetary unification. We are primarily interested in Europe's monetary union. Given that unification entails the loss of a policy instrument, its potential benefits have to be found elsewhere. Unification may serve as a vehicle for beneficial institutional changes. In particular, it may be a route toward an independent monetary policy, which alleviates the scope for political pressure to relax monetary policy. Unification also eliminates harmful monetary policy spillovers and competitive devaluations. We explore how disagreement between the monetary and fiscal authorities about their policy objectives can lead to extreme macroeconomic outcomes. Further, we pay considerable attention to the desirability (or not) of fiscal constraints and fiscal coordination in a monetary union. Monetary commitment and fiscal free riding play a key role in this regard. Similar free-riding issues also feature prominently in the analysis of how unification influences structural reforms. We end with a brief discussion of monetary unification outside Europe. The cost-benefit trade-off of unification may differ substantially between industrialized and less-developed countries, where differences in fiscal needs and, hence, the reliance on seigniorage revenues may dominate the scope for unification.