Low Inflation vs. Stable Inflation: Evidence from the UK, 1688–2009

This paper investigates the relationship between inflation and inflation volatility. Using annual data from 1688 to 2009, the results show that UK inflation and its volatility have been positively correlated when inflation exceeds a certain value, but negatively correlated when inflation is below this threshold. The evidence also suggests that the break in the relationship occurs between annual inflation rates of 0.6% and 5.5%, which includes both the 2% inflation target of many central banks, and the 3.5% break point predicted by the New Keynesian model of Coibion et al. (2012).     

The emerging global financial architecture and exchange rate regimes in a volatile world

Previous work has documented inflation effects on Tobin's q in the long run. This paper examines whether the FED's different policies and chairmen tenure have an impact on Tobin's q, after a modified stylized AD-AS model shows that central banks affect q. We do find changing responses of q depending on the pre-Volcker and post-Volcker periods.     

BANK EFFICIENCY AND THE EFFECTIVENESS OF MONETARY POLICY

Advances in information technology and bank consolidation have altered the way banks operate by necessitating that banks control costs and provide services efficiently to remain competitive. Given the unique role bank operations play in the transmission of monetary policy, a key unresolved question is whether bank efficiency alters monetary policy outcomes. Using a stochastic frontier approach to measure cost‐efficiency and panel data of U.S. bank balance sheets, we show that banks with greater cost‐efficiency are more sensitive to monetary shocks. (JEL E52, E44, E51)     

Teaching Inflation Targeting: An Analysis for Intermediate Macro

Over the last decade, many central banks have adopted policies known as inflation targeting. If intermediate-level macroeconomics students are to be prepared to think about current policy issues, it is important to provide them with an introduction to the macroeconomic implications of inflation targeting. Unfortunately, the standard aggregate demand-aggregate supply frameworks commonly used to teach intermediate macroeconomics are not well suited for this task because they are expressed in terms of output and the price level and because they fail to make explicit the policy objectives of the central bank. The author provides a simple graphical device involving the output gap and the inflation rate that overcomes these problems and that can be used to teach intermediate macroeconomics students about inflation targeting.     

On Hayek's denationalization of money,free banking and inflation targeting 1

Abstract

Recent central bank experience with inflation targeting is used to restate Hayek's reform proposal as a performance contract. This requires banks to first state an explicit inflation target and then promise to perform a set of actions whenever an independent forecast departs from target. Making such actions explicit and observable makes the promise of price stability offered by competing banks operational and enforceable. Competition among banks then leads to convergence on current best practice in the short term and to faster performance evolution as the incentive to innovate induces improvements over the long term.     

IDENTIFYING THE EFFECTS OF SIMULTANEOUS MONETARY POLICY SHOCKS

Many central banks, particularly in the developing world, aim for exchange rate stability as a macroeconomic goal. However, most are reluctant to relinquish monetary policy autonomy, so they end up operating through both interest rate and foreign exchange interventions. But the use of multiple policy instruments does not necessarily equip monetary authorities with better tools to achieve their targets. On the contrary, their effects can potentially offset each other. Using daily data from the Central Bank of Colombia during the period of 1999–2012, I study the effects of simultaneous policies by first deriving new measures of monetary shocks and then determining their impact on economic activity. The main findings indicate that (a) while interest rate interventions have a significant impact on real and nominal variables, foreign exchange interventions tend to have limited effects; and (b) empirical anomalies, such as the positive relationship between output growth, inflation, and the policy rate are eliminated when properly accounting for the systematic responses of policy. (JEL E43, E52, E58, F31)     

CAN SECRET INTERVENTION BE COMPATIBLE WITH A NON‐PROFITMAKING CENTRAL BANK AND A FUNDAMENTAL‐CONSISTENT TARGET?

The coexistence of secret intervention operations and “the signaling channel” (Mussa. The Role of Official Intervention, 1981) seems confusing. Vitale ( Journal of International Economics, 49, 1999, 245–267) resolves this puzzle by employing an asymmetric information framework and an assumption of a fundamental‐inconsistent target for the exchange rate. Ferré and Manzano ( International Journal of Finance and Economics, 14, 2009, 378–393) follow Vitale's microstructure framework and argue that the central banks' profitability motivation offers a rationale for their secret intervention even under a target consistent with the fundamentals. However, that the authority uses its superior information to obtain speculative profits through secret intervention in the market is not a typical goal for central banks. To theoretically explain the opaqueness in non‐profitmaking central banks' exchange rate policies, we employ a model of a central bank's optimization by considering that no bank really knows the exact fundamental rate and they take into account the possible bad consequences of announcing the intervention. We also show that, in passing the bank's private information to market participants, a bank's announcement of the intervention size is equivalent to revealing its target rate. (JEL E58, F39)     

HOW DID UNCONVENTIONAL MONETARY POLICY AFFECT ECONOMIC FORECASTS?

We study how unconventional monetary policy announcements affected professional forecasters' predictions of bond rates, gross domestic product growth and inflation using data from the monthly survey by the Wall Street Journal. We find that unconventional monetary policy (UMP) announcements moved predicted bond rates in the direction the Fed intended. UMP announcements had differential impacts on forecasters' predictions; they also tended to move growth and inflation predictions in directions opposite those the Fed intended due to Fed information effects. A policy implication of our study is that the Fed should communicate economic projections to the public separately from monetary policy announcements to mitigate Fed information effects. (JEL E52, E58)     

Income velocity and non-GDP transactions in the UK

It is widely reported for many countries, including the UK, that income velocity has been highly variable around a declining trend in recent years. This paper advances the following hypothesis. The demand for credit and hence the broad money stock are influenced by total spending in the economy, rather than spending only on newly produced goods and services. Since total spending in the economy has generally increased relative to GDP (mainly because of asset transactions) credit and money have expanded more rapidly than GDP, with the resulting fall in income velocity. Using quarterly data from 1975 to 2008, we estimate a vector error correction with income velocity as the dependent variable and the ratio of total to GDP transactions as an explanatory variable. The results show substantial support for the hypothesis and raise (further) doubts about the information content of broad money aggregates for inflation targeting central banks.     

Signalling commitment with monetary and inflation targets

This article studies a two-period game between the public and a central bank about whose ability to commit to an announced target the public is uncertain. The central bank chooses between announcing a target for an intermediate variable (money growth) and its goal variable, inflation. Prior to setting its instrument, the central bank receives private, noisy information about the link between money growth and inflation. Monetary targeting facilitates communication of the central bank's type, in that the probability of separation is always higher than under inflation targeting. This advantage of monetary targets from a dependable central bank's perspective is outweighed for most parameter values by the advantage of inflation targeting in terms of inflation control. If the regime choice is treated as a strategic decision, over a large range of parameter values both central banks choose the regime that a dependable central bank would prefer.     

The Inflation Game: Targets,Practices and the Social Production of Monetary Credibility

In recent years, central banks have continued to preach inflation targeting even as they have pursued a wide range of unorthodox inflation-management policies. As the disconnect between discourse and practice grows, there is a growing risk of a serious credibility gap. This article seeks to shed some light on these dilemmas by looking backwards, focusing on the ‘Great Inflation’ in Britain in the 1970s and early 1980s and the successive failures of Labour’s incomes policy and the Conservatives’ monetarist experiment. These historical experiences suggest that for inflation policy to work it needs to be both understood as and made credible—which means that key actors need to not only learn that this is how the inflation game works, but also put into place a whole range of supporting practices that reflect and reproduce this conviction. In spite of the many claims by economists and central bankers to the contrary, quantitative targets do not in fact anchor inflationary expectations – social practices instead play that crucial anchoring role. At the same time, these cases both underline the particular dilemmas associated with a reliance on hard quantitative targets in times of social instability – lessons that do not bode well for our present moment.     

Monetary policy rules with PID control features: evidence from the UK,USA and EU

ABSTRACT

This paper considers the extent to which the monetary policy operations of three major central banks can be regarded as an application of Proportional-Integral-Derivative (PID) control rules. The paper outlines the general PID framework and estimates a series of dynamic models to identify how interest rate policy adjustments are affected by the rate of inflation and the level of macroeconomic activity. The paper examines data for the UK, the USA and the Eurozone. The results suggest that the PID rules can provide a useful theoretical and empirical framework for estimating central bank responses to the inflation and macroeconomic activity variables by improving the explanatory power of the Taylor rule model and determining the effect of the parameters.     

Inequality, inflation, and central bank independence

What can account for the different contemporaneous inflation experiences of various countries, and of the same country over time? We present an analysis of the determination of inflation from a political economy perspective. We document a positive correlation between income inequality and inflation and then present a theory of the determination of inflation outcomes in democratic societies that illustrates how greater inequality leads to greater inflation, owing to a desire by voters for wealth redistribution. We conclude by showing that democracies with more independent central banks tend to have better inflation outcomes for a given degree of inequality. JEL Classification E5, H0 Inégalité, inflation et l'indépendance de la banque centrale. Quels sont les facteurs qui pourraient expliquer les expériences inflationnistes tellement différentes des divers pays dans le passé récent, et l'expérience tellement différente d'un pays donné dans le temps? Les auteurs analysent ce problème de la détermination du taux d'inflation dans une perspective d'économie politique. Ils déterminent qu'il y a une corrélation positive entre l'inégalité et l'inflation, et présentent une théorie de la détermination de l'inflation dans les sociétés démocratiques qui montre comment une inégalité plus grande entraîne une inflation plus grande à cause du désir des électeurs de demander une redistribution de la richesse. Le mémoire montre en terminant que les démocraties e´quipées de banques centrales plus indépendantes tendent à avoir de meilleurs résultats en terme d'inflation pour un degré d'inégalité donné.     

WINDOW GUIDANCE BY THE BANK OF JAPAN: WAS LENDING CONTROLLED?

Over the period 1961–1991, the Bank of Japan (BOJ) attempted to directly control the volume of commercial bank credit by providing lending targets for selected banks. This policy of “window guidance” (WG) applied to only a subset of lending institutions. The guided banks involved were under no legal obligation to heed the BOJ's requests. Using actual WG data to city banks, two questions are addressed. First, did city banks comply with WG (the “compliance hypothesis”)? Second, was WG successful in controlling economywide lending or did lending adjustments by other financial institutions simply displace the lending of guided banks (the “displacement hypothesis”)? The empirical results show a high degree of compliance in the first two decades of the program and evidence of weakening in the final years. The displacement hypothesis is rejected, particularly in the early period of highly regulated financial markets. (JEL E58, E51, E52)     

Is the monetary policy rule responsive to exchange rate changes? The case of Indonesia,Malaysia, the Philippines,and Thailand

Extending Obstfeld and Rogoff (J Econ Perspect 9:73–96, 1995), Ball (Monetary policy rules, University of Chicago Press, pp. 127–144, 1999), Svensson (J Int Econ 50: 155–183, 2000), Taylor (Am Econ Rev 91: 263–267, 2001), Gali and Gertler (J Econ Perspect 21:25–46, 2007), and others, this paper finds that central banks in the Philippines and Thailand respond negatively to the current real exchange rate and positively to the lagged real exchange rate whereas central banks in Indonesia and Malaysia do not react to the current or lagged real exchange rate. For the Philippines and Thailand, the null hypothesis that the sum of the coefficients of the current and lagged real exchange rates is zero cannot be rejected at the 5% level. Central banks in these four countries respond positively to the inflation rate and the output gap, suggesting that the concept of a simple or an extended Taylor rule would apply to these countries. Monetary policy reaction functions for Indonesia and Thailand are steeper than those for Malaysia and the Philippines and would be more responsive to a change in the inflation rate.      

The emerging Russian banking system1

Value-added in Russian banks grew by 43 per cent while GDP declined by 32 per cent in the early years of the transition in Russia. This paper offers explanations for the unusual success of the Russian banking sector and the determinants of individual bank performance. The evidence comes from balance sheet data for 563 Moscow banks and 160 regional banks on January 1, 1995 and January 1, 1996. Important factors include the Central Bank policy of channelling low-interest directed credits to state enterprises through banks, the ability of banks to obtain large-scale interest-free deposits, and the resulting high interest rate spreads in an environment of high inflation, and the extent to which banks were formerly part of the Soviet system.     

The inflationary bias of real uncertainty and the harmonic Fisher equation

Summary. We argue that real uncertainty itself causes long-run nominal inflation. Consider an infinite horizon cash-in-advance economy with a representative agent and real uncertainty, modeled by independent, identically distributed endowments. Suppose the central bank fixes the nominal rate of interest. We show that the equilibrium long-run rate of inflation is strictly higher, on almost every path of endowment realizations, than it would be if the endowments were constant.Indeed, we present an explicit formula for the long-run rate of inflation, based on the famous Fisher equation. The Fisher equation says the short-run rate of inflation should equal the nominal rate of interest less the real rate of interest. The long-run Fisher equation for our stochastic economy is similar, but with the rate of inflation replaced by the harmonic mean of the growth rate of money.Received: 25 February 2005, Revised: 26 May 2005, JEL Classification Numbers: C7, C73, D81, E41, E58.An earlier version of this paper “Inflationary Bias in a Simple Stochastic Economy,” as a 2001 Cowles Foundation Discussion Paper No. 1333.     

Modifying Taylor reaction functions in the presence of the zero‐lower‐bound — Evidence for the ECB and the Fed

We propose an alternative way of estimating Taylor reaction functions if the zero‐lower bound on nominal interest rates is binding. This approach relies on tackling the real rather than the nominal interest rate. So if the nominal rate is (close to) zero central banks can influence the inflation expectations via quantitative easing. The unobservable inflation expectations are estimated with a state‐space model that additionally generates a time varying series for the equilibrium real interest rate and the potential output — both needed for estimations of Taylor reaction functions. We test our approach for the ECB and the Fed within the recent crisis. We add other explanatory variables to this modified Taylor reaction function and show that there are substantial differences between the estimated reaction coefficients in the pre‐ and crisis era for both central banks. While the central banks on both sides of the Atlantic act less inertially, put a smaller weight on the inflation gap, money growth and the risk spread, the response to asset price inflation becomes more pronounced during the crisis. However, the central banks diverge in their response to the output gap and credit growth.     

Inflation and growth: new evidence from a dynamic panel threshold analysis

We introduce a dynamic panel threshold model to estimate inflation thresholds for long-term economic growth. Advancing on Hansen (J Econom 93:345–368, 1999) and Caner and Hansen (Econom Theory 20:813–843, 2004), our model allows the estimation of threshold effects with panel data even in case of endogenous regressors. The empirical analysis is based on a large panel-dataset including 124 countries. For industrialized countries, our results confirm the inflation targets of about 2% set by many central banks. For non-industrialized countries, we estimate that inflation rates exceeding 17% are associated with lower economic growth. Below this threshold, however, the correlation remains insignificant.