Showing papers on "Price level published in 1996"

The Purchasing Power Parity Puzzle

Abstract: FIRST ARTICULATED by scholars of the ISalamanca school in sixteenth century Spain,1 purchasing power parity (PPP) is the disarmingly simple empirical proposition that, once converted to a common currency, national price levels should be equal. The basic idea is that if goods market arbitrage enforces broad parity in prices across a sufficient range of individual goods (the law of one price), then there should also be a high correlation in aggregate price levels. While few empirically literate economists take PPP seriously as a short-term proposition, most instinctively believe in some variant of purchasing power parity as an anchor for long-run real exchange rates. Warm, fuzzy feelings about PPP are not, of course, a substitute for hard evidence. There is today an enormous and evergrowing empirical literature on PPP, one that has arrived at a surprising degree of consensus on a couple of basic facts. First, at long last, a number of recent studies have weighed in with fairly persuasive evidence that real exchange rates (nominal exchange rates adjusted for differences in national price levels) tend toward purchasing power parity in the very long run. Consensus estimates suggest, however, that the speed of convergence to PPP is extremely slow; deviations appear to damp out at a rate of roughly 15 percent per year. Second, short-run deviations from PPP are large and volatile. Indeed, the one-month conditional volatility of real exchange rates (the volatility of deviations from PPP) is of the same order of magnitude as the conditional volatility of nominal exchange rates. Price differential volatility is surprisingly large even when one confines attention to relatively homogenous classes of highly traded goods. The purchasing power parity puzzle then is this: How can one reconcile the enormous short-term volatility of real exchange rates with the extremely slow rate at which shocks appear to damp out? Most explanations of short-term exchange rate volatility point to financial factors such as changes in portfolio preferences, short-term asset price bubbles, and monetary shocks (see, for example, Maurice Obstfeld and Rogoff forthcoming). Such shocks can have substantial effects on the real economy in the presence of sticky nominal wages and prices. I See Lawrence H. Officer (1982, ch. 3) for an extensive discussion of the origins of PPP theory; see also Dornbusch (1987).

Do Real Output and Real Wage Measures Capture Reality? The History of Lighting Suggests Not

Abstract: Historical studies of the growth in real wages and output depend upon the accurate measure of the price trends of goods and services. Over long periods of time, the consumption bundle has changed profoundly, and most of today's consumption includes items that were not produced, and in some cases not even conceived, at the beginning of the nineteenth century. This paper tackles the issue of the quantitative significance of the qualitative change in consumption by choosing a single service -- lighting -- for which the service characteristic -- illumination -- is invariant. We estimate changes in lighting efficiency and construct a "true" price index back to Babylonian times, with the major emphasis on changes over the last two centuries. A comparison of the true price of light with a traditional light price indicates that traditional price indexes overstate price growth, and therefore understate output growth, by a factor between 900 and 1,600 since the beginning of the nineteenth century. This finding suggests that the "true" growth of real wages and real output may have been significantly understated during the period since the Industrial Revolution.

Control of the Public Debt: A Requirement for Price Stability?

Abstract: The paper considers the role of limits upon the permissible growth of public debt, like those stipulated in the Maastricht treaty, in making price stability possible. It is shown that a certain type of fiscal instability, namely variations in the present value of current and future primary government budgets, necessarily results in price level instability, in the sense that there exists no possible monetary policy that results in an equilibrium with stable prices. In the presence of sluggish price adjustment, the fiscal shocks disturb real output and real interest rates as well. On the other hand, shocks of this kind can be eliminated by a Maastricht-type limit on the value of the public debt. In the presence of the debt limit (and under assumptions of frictionless financial markets, etc.), Ricardian equivalence holds, and fiscal shocks have no effects upon real or nominal variables. Furthermore, an appropriate monetary policy rule can ensure price stability even in the face of other kinds of real shocks. Thus the debt limit serves as a precondition for the common central bank in a monetary union to be charged with responsibility for maintaining a stable value for the common currency.

Price Level Targeting vs. Inflation Targeting: A Free Lunch?

Abstract: Price level targeting (without base drift) and inflation targeting (with base drift) are compared under commitment and discretion, with persistence in unemployment. Price level targeting is often said to imply more short-run inflation variability and thereby more employment variability than inflation targeting. Counter to this conventional wisdom, under discretion a price level target results in lower inflation variability than an inflation target (if unemployment is at least moderately persistent). A price level target also eliminates the inflation bias under discretion and, as is well known, reduces long-term price variability. Society may be better off assigning a price level target to the central bank even if its preferences correspond to inflation targeting. A price level target thus appears to have more advantages than commonly acknowledged.

The Costs and Benefits of Going from Low Inflation to Price Stability

Abstract: This paper evaluates the welfare gain from achieving price stability and compares it to the cost of the transition. In calculating the gain from price stability, the paper emphasizes the distortions caused by the interaction of inflation and capital income taxes. Because inflation exacerbates the tax distortions that would exist even with price stability, the annual deadweight loss of a two percent inflation rate is a surprisingly large one percent of GDP. Since the real gain from shifting to price stability grows in perpetuity at the rate of growth of GDP, its present value is a substantial multiple of this annual gain. Discounting the annual gains at the rate that investors require for risky equity investments (i.e., at the 5.1 percent real net-of-tax rate of return on the Standard and Poors portfolio of equities from 1970 to 1994) implies a present value gain equal to more than 35 percent of the initial level of GDP. Since the estimated cost of shifting from two percent inflation to price stability is about five percent of GDP, the gain substantially outweighs the cost of transition.

Sticky price and limited participation models of money: a comparison

Abstract: We provide new evidence that models of the monetary transmission mechanism should be consistent with at least the following facts. After a contractionary monetary policy shock, the aggregate price level responds very little, aggregate output falls, interest rates initially rise, real wages decline by a modest amount, and profits fall. We compare the ability of sticky price and limited participation models with frictionless labor markets to account for these facts. The key failing of the sticky price model lies in its conterfactual implications for profits. The limited participation model can account for all the above facts, but only if one is willing to assume a high labor supply elasticity (2 percent) and a high markup (40 percent). The shortcomings of both models reflect the absence of labor market frictions, such as wage contracts of factor hoarding, which dampen movements in the marginal cost of production after a monetary policy shock. nerships or affiliated with banking organizations are less likely to provide debt financing than other SBICs.

Mismeasurement in the Consumer Price Index: An Evaluation

Abstract: A number of analysts have claimed recently that the consumer price index overstates the annual increase in the cost of living. This paper develops a framework for studying measurement problems in the consumer price index and systematically analyzes the available evidence concerning the magnitude of these problems. It concludes that the CPI overstates increases in the cost of living. The evidence suggests that the bias is centered on 1.0 percentage point per year. The extent of this bias is not known exactly. To take into account this uncertainty, the estimated bias is presented in terms of a probability distribution rather than a point estimate or range. We estimate that there is a 10 percent chance that the bias is less than 0.6 percentage point and a 10 percent chance that it is greater than 1.5 percentage points per year. CPI procedures overstate the rate of inflation for medical procedures that are subject to technological improvement. To illustrate this point and to show how better to measure medical care prices, the paper presents a prototypical price index for cataract surgery. This price index grows much more slowly than a price index for cataract surgery constructed using the methodology of the CPI. The paper discusses implications of CPI mismeasurement for monetary and fiscal policy as well as for other official statistics. It also offers some suggestions for improving the CPI.

Inflation, Asset Prices, and the Term Structure of Interest Rates in Monetary Economics

Abstract: This article offers a tractable monetary asset pricing model. In monetary economies, the price level, inflation, asset prices, and the real and nominal interest rates have to be determined simultaneously and in relation to each other. This link allows us to relate in closed form each of the dependent entities to the underlying real and monetary variables. Among other features of such economies, inflation can be partially nonmonetary and the real and nominal term structures can depend on fundamentally different risk factors. In one extreme, the process followed by the real term structure is independent of that followed by its nominal counterpart. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Relative Price Variability and Inflation: Evidence from Us Cities

Abstract: We test whether the time-series positive correlation of inflation and intermarket relative price variability is also present in a cross section of U.S. cities. We find this correlation to be a robust empirical regularity: cities that have higher than average inflation also have higher than average relative price dispersion, ceteris paribus. This result holds for different periods of time, for different classes of goods, and across different time horizons. Our results suggest that at least part of the relationship between inflation and relative price variability cannot be explained by monetary factors.

Limits on interest rate rules in the IS model

Abstract: There are a few limits on interest rate rules in the textbook sticky price macroeconomic model. A central bank can even use a 'pure' rule that sets the interest rate arbitrarily. However, modern consumption and investment theory suggests that expectations of future output enter the IS schedule. With this modification, a pure interest rate rule is either infeasible or undesirable. Yet, interest rate rules that target the price level or the inflation rate can be feasible.

Inflation and Relative Price Variability in the Short and Long Run: New Evidence from the United States

Abstract: This paper presents new evidence that a positive association exists between inflation and relative prices and relative inflation rates in very disaggregated data for the United States over the period 1975 through 1992. There is also evidence that the response of relative prices and relative inflation rates to inflation varies inversely with the information content of a given shock to inflation. The relationship is studied from two cross-sectional perspectives using individual price series collected from forty-eight U.S. cities. Evidence on the persistence of the effects of inflation on relative prices is also presented. Results here demonstrate the absence of a long run relationship between inflation and relative price dispersion, i.e., the two series are not cointegrated. Finally, results from vector autoregressions further imply the effect is smaller than indicated by typical estimates. Copyright 1996 by Ohio State University Press.

Measuring Short-Run Inflation for Central Bankers

Abstract: As central bankers intensify their focus on inflation as the primary goal of monetary policy, it becomes increasingly important to have accurate and reliable measures of changes in the aggregate price level. Measuring inflation is surprisingly difficult, involving two types of problems. Commonly used indices, such as the Consumer Price Index (CPI), contain both transitory noise and bias. Noise causes short-run changes in measured inflation to inaccurately reflect movements in long-run trends, while bias leads the long-run average change in the CPI to be too high. In this paper I propose methods of reducing both the noise and the bias in the CPI. Noise reduction is achieved by average monthly inflation in measures called trimmed means' over longer horizons. Trimmed means are statistics similar to the median that are calculated by ignoring the CPI components with extreme high and low changes each month, and averaging the rest. I find that using three month averages halves the noise, while removing the highest and lowest ten percent of the cross-sectional distribution of inflation reduces the monthly variation in inflation by one-fifth.

The Statistical Approach to Social Measurement

Abstract: Part 1 Measurement: problems and strategy validity and reliability. Part 2 Labour wastage: inequality mobility price levels. Part 3 Population and individual level measures: common scaling of individuals and items individual level measurement - general theory principles and problems of implementation extensions and limitations.

A Dynamic Model of Reference Price and Expected Quality

Abstract: A number of recent papers have developed normative implications of the concept of reference price. In this paper, we extend that literature to incorporate the relationship between expected quality and reference price. We consider the case of a monopolist who makes time-varying decisions regarding price and product quality. Our results suggest that when the effect of a loss (price greater than reference price and product quality less than expected quality) on demand is greater than or equal to that of a corresponding gain, it is optimal for a monopolist to have constant price and product quality levels. When the effect of a gain on demand is greater than that of a corresponding loss, however, we find that it is optimal to maintain cyclical pricing and product quality policies.

Water and Energy Price Impacts on Residential Water Demand in Copenhagen

Abstract: While water price effects on residential water demand have been studied for several decades, the impact of energy prices does not seem to have received much attention. In this paper a residential water demand function-derived from a model of household production of final consumption goods taking water, energy, and an aggregate of other goods as inputs-is estimated on pooled time series data. We find negative energy cross-price elasticities around -0.2 and water price elasticities in the order of -0.1 or smaller.

Food Price Variability and Economic Reform: An ARCH Approach for Ghana

Abstract: Changes in maize price levels and variability in Ghana are investigated. A model of wholesale price determination is reviewed in which grain stocks are held for speculative storage as well as export to neighboring countries in the Sahel. To test the model, an Autoregressive Conditionally Heteroskedastic (ARCH) regression is applied to monthly maize data for two markets over the period 1978–93. The regression is used to measure changes in maize price volatility in Ghana, and to infer the importance of past prices, domestic and regional production, and commodity storage and trade in explaining these changes.

Are Medical Prices Declining

Abstract: We address long-standing problems in measuring health care prices by estimating two medical care price indices. The first, a Service Price Index, prices specific medical services, as does the current CPI. The second, a Cost of Living Index, measures the net valuation of treating a health problem. We apply these indices to heart attack treatment between 1983 and 1994. Because of technological change and increasing price discounts, the current CPI overstates a chain-weighted price index by three percentage points annually. For plausible values of an additional life-year, the real Cost of Living Index fell about 1 percent annually.

Price-level Targeting versus Inflation Targeting: A Free Lunch?

Abstract: Price-level targeting (without base drift) and inflation targeting (with base drift) are compared under commitment and discretion, with persistence in unemployment. Price-level targeting is often said to imply more short-run inflation variability and thereby more employment variability than inflation targeting. Counter to this conventional wisdom, under discretion a price-level target results in lower inflation variability than an inflation target (if unemployment is at least moderately persistent). A price-level target also eliminates the inflation bias under discretion and, as is well known, reduces long-term price variability. Society may be better off assigning a price-level target to the central bank even if its preferences correspond to inflation targeting. A price-level target thus appears to have more advantages than commonly acknowledged.

Fiscal Constraints on Central Bank Independence and Price Stability

Abstract: We use a new theory of price determination – developed by Woodford, Simms and others – to characterize central bank independence and price stability. If fiscal policy guarantees that the price level is determined independently of government’s present value budget constraint, we can say that the central bank is operating in a monetary dominant regime; it has the ‘functional independence’ necessary to control the price level independently of the dictates of fiscal solvency (if it so chooses), and it can be held accountable for price stability (if that is its mandate). If fiscal policy does not allow this, we say the central bank is operating in a fiscal dominant regime. Numerical exercises suggest that price stability may be beyond the control of the central bank in such a regime. We show that strict enforcement of the Maastricht Treaty’s deficit criterion would ensure a monetary dominant regime.

The Dynamic Responses of Crop and Livestock Prices to Money-Supply Shocks: A Bayesian Analysis Using Long-Run Identifying Restrictions

Abstract: The impact of monetary policy on agriculture has been much debated. This study examines the dynamic responses of U.S. agricultural prices to money-supply shocks using three innovations. First, the variables' responses are identified by long-run money neutrality restrictions instead of the more common contemporaneous ordering. Second, a Bayesian approach to model uncertainty is used to add robustness to the estimation process. Third, agricultural prices are disaggregated into crop and livestock components. The empirical results find that both agricultural sectors benefit in the short run from positive money-supply shocks with agricultural prices increasing relative to the general price level.

Vietnam : Transition to a Market Economy

Abstract: The paper explores the pattern of transition of the Vietnamese economy, the policies that were applied, and the reasons for the country's success. In particular, it focuses on output performance; state-owned enterprises; foreign direct investment; determinants of inflation; dollarization and problems of economic management; international integration and exchange rate policy; growth and diversification of trade, trade reform, exchange reform, and exchange rate policy.

America's Only Peacetime Inflation: The 1970s

Abstract: The 1970s were America's only peacetime inflation, as uncertainty about prices made every business decision a speculation on monetary policy. In magnitude, the total rise in the price level from the spurt in inflation to the five-to-ten percent per year range in the 1970s was as large as the jumps in prices from the major wars of this century. The truest cause of the 1970s inflation was the shadow of the Great Depression. The memory left by the Depression predisposed the left and center to think that any unemployment was too much, and eliminated any mandate the Federal Reserve might have had for controlling inflation by risking unemployment. The Federal Reserve gained, or regained, its mandate to control inflation at the risk of unemployment during the 1970s as discontent built over that decade's inflation. It is hard to see how the Federal Reserve could have acquired such a mandate without an unpleasant lesson like the inflation of the 1970s. Thus the memory of the Great Depression meant that the U.S. was highly likely to suffer an inflation like the 1970s in the post-World War II period þ maybe not as long, and maybe not in that particular decade, but nevertheless an inflation of recognizably the same genus.

Sticky Wage or Sticky Price? Analysis of the Cyclical Behavior of the Real Wage

Abstract: The study of business cycles has been at the heart of macroeconomic theory for decades. Theoretical efforts have focused on providing an adequate explanation for sources of economic fluctuations. New Keynesian explanations have emphasized rigidity that interferes with market forces, increasing the effect of demand shocks on the output produced. The form of rigidity is in sharp contrast between sticky-wage and sticky-price models. The former imposes rigidity on the shortrun adjustment of wages to demand shocks [20; 47]. The latter, in contrast, imposes rigidity on the short-run price adjustment to demand shocks [2; 34; 40; 9; 43; 4]. The theoretical plausibility of competing explanations of business cycles has stimulated interest to establish their empirical validity. [32; 28; 1; 8; 11; 23; 21; 26]. These efforts have focused attention on cyclical fluctuations of the real wage in response to demand shocks. The real wage may move procyclically or countercyclically according to the relative adjustment of wages and prices. The interest in studying the cyclical behavior of the real wage relates to its implications to the real effects of aggregate demand shocks. In the context of sticky-wage models, nominal wage rigidity reinforces the countercyclical response of the real wage to demand shocks and the real effect of these shocks on output growth. Sticky-price models, in contrast, advocate that price rigidity increases the procyclical response of the real wage to demand shocks and their real effect on output growth.' The results of earlier investigations of the cyclical behavior of the real wage appear conflicting and, therefore, do not lend support to a given explanation.2 The present investigation seeks to contribute to this literature. Unlike previous empirical research on the subject, the objective of this investigation is to study the cyclical behavior of the real wage and the relative flexibility of the nominal wage and the price level that determines this behavior in response to demand shocks. Using data for the United States in the preand post-World War II sample periods, the cyclical

Hedonic-based price indexes for housing: theory, estimation, and index construction

Abstract: Housing price indexes should not confound the effect of changes in quality with the effects of changing house prices. A recent nonparametric regression technique, loess, allows flexible estimation of the hedonic price function and centers the estimation at fixed points, such as the beginning or ending period housing characteristics. Indexes using these estimates are consistent with the requirements of Laspeyres and Paasche price indexes. The technique is used to obtain indexes for fifteen municipalities in Alameda County from 1970:Q1 through 1995:Q1. The nonparametric hedonic-based indexes provide better controls for the effect of quality evolution on price movements than alternative methods.