Inflation Dynamics in India: Relative Role of Structural and Monetary Factors

This paper examines the relative role of structural and monetary factors in the variation of inflation in India over the period 1996–1997:Q1 to 2013–2014:Q4. The paper finds that both the monetary factors and the output gap has significant role. The role of the output gap in inflation is found more prominent than the monetary factors like broad money growth, interest rate and change in exchange rate. The depreciation of exchange rate and broad money growth stimulates inflation where as the interest rate is identified as an anti-inflationary monetary instrument. In view of a comprehensive policy for price stability, it is imperative to know the role of sectoral output gap in inflation. The paper, therefore, enquires the relative role of the primary, secondary and tertiary sector output gap in inflation. Output gap of each of these three sectors provokes inflation where the contribution of tertiary sector output gap is found to be the maximum followed by the primary sector and the secondary sector output gap. The prominent role of the output gap and comparatively passive role of monetary factors does not necessarily imply a non-effective monetary policy but suggests that controlling inflation only through the monetary management may not be effective.

     

Does money have a role in the inflation process? Evidence from Australia

Inflation, defined as a sustained increase in the price level, is considered a monetary phenomenon, as it can be explained within the framework of money‐demand and money‐supply relationships. In the extant literature, money growth is shown to remain causally related to inflation across countries and over time, irrespective of the exchange rate regime and stability of the money‐demand function. Nevertheless, emerging literature suggests a diminishing role of money in the conduct of monetary policy for price stability, especially under inflation targeting. Monetary policy in Australia under inflation targeting since 1993 is an example of policy that denies a relationship between money growth and inflation. The proposition that money does not matter insofar as inflation is concerned seems odd in both theory and the best‐practice monetary policy for price stability. This paper uses annual data for the period 1970–2017 and quarterly data for the period 1970Q1–2015Q1. It deploys both the Johansen cointegration approach and the autoregressive distributed lag (ARDL) cointegration approach to investigate for Australia whether money, real output, prices and the exchange rate (non‐stationary variables) maintain the long‐run price‐level relationship that the classical monetary theory suggests in the presence of such stationary variables as the domestic and foreign interest rates. As expected, the empirical findings for Australia are consistent with the classical long‐run price‐level relationship between money, real output, prices and the exchange rate. The error‐correction model of inflation confirms the presence of a cointegral relationship among these variables; it also provides strong evidence of a short‐run causal relationship between money supply growth and inflation. On the basis of a priori theoretical predictions and empirical findings, the paper draws the conclusion that the monetary aggregate and its growth rate matter insofar as inflation is concerned, irrespective of the strategy of monetary policy for price stability.     

The role of the exchange rate in Canadian monetary policy: evidence from a TVP-BVAR model

A time-varying parameters Bayesian structural vector autoregression (TVP-BVAR) model with stochastic volatility is employed to characterize the monetary policy stance of the Bank of Canada (BoC) in terms of an interest rate rule linking the policy rate to the output gap, inflation and the exchange rate. Using quarterly bilateral Canadian–US data, we find such an interest rate rule to have little explanatory power for the early part of our sample starting in the mid-1980s, but to become more suitable to explain interest rate dynamics from the mid-1990s onwards. Whereas the exchange rate turns out to be the major determinant of the policy rate in the 1980s, its importance declines throughout the 1990s and 2000s, although it continues to be influential even towards the end of the sample period ending in 2015Q2. We also find interest rate shocks to have become more effective in influencing the macroeconomy over time, indicating that the BoC has continually gained monetary policy credibility. We associate this development with the BoC successively de-emphasizing the role of the exchange rate in informing interest rate decisions, thereby alleviating the potential monetary policy conflict between targeting the exchange rate and maintaining the price stability goal.     

The Impact of Budget Deficits on Real Interest Rates: An International Empirical Investigation

In this study, an attempt is made to asses the empirical relationship between the short-term real rate of interest and government budget deficit for five industrialized countries during the period of 1965Q1–1985Q4. Contrary to the conclusions reported earlier by some, the results do not support a statistically significant relationship between budget deficit spending and the real interest rate. Alternative estimations of the basic model with money supply and government spending as other determinants of the real interest rate did not alter the fundamental conclusion reached. [310]     

Impact of foreign prices and interest rates on canadian economy under alternative monetary and exchange rate regimes

The main objective of this paper is to analyze the impact of U.S. short- and long-term monetary policy under both flexible and managed floating systems, using the new CANDIDE Model 2.0. We have also examined the role of domestic monetary policy in the Canadian economy under both fixed and flexible exchange rate systems. The following are some of the important findings of our study:

1. Our results support the traditional view that under the fixed exchange rate regime, monetary authorities cannot successfully pursue an independent monetary policy from its trading partners — an effort to increase money supply will be almost offset by increases in the balance of payments deficit. In contrast, in the flexible exchange rate regime, monetary policy is more effective in producing an increased growth in output and employment. However the increased output growth comes at the cost of higher prices induced by increased wages and a depreciation of the Canadian dollar.
2. Our results suggest that the impact of U.S. interest rates on investment, GNE, employment, productivity, and government debt is less severe in a pure floating exchange rate regime, compared to the managed floating system. However, the impact of U.S. interest rate policy on the Canadian inflation rate is worse in the case of flexible exchange rate regime. Even though real income and inflation are less favourable in both cases, our results indicate a trade-off between output growth and inflation.
3. Our results imply that under a pure floating monetary authorities can determine the long-run rate of inflation in Canada independent of others. However, the United States and Canadian economies are interrelated during the adjustment process, even under the flexible exchange rates, through the terms of trade and the wage-price spiral channels.

     

How does the flow of remittances affect the trade balance of the Middle East and North Africa?

ABSTRACT

The Middle Eastern and North African (MENA) economies have one of the highest degrees of dependency on received remittances worldwide. In this study, we have examined the role of remittances in the trade balance of 11 labour abundant MENA countries. Our panel regression analysis showed that the inflow of remittances has fostered the trade deficit. We also found that the final effect of remittances depends on the level of domestic capital formation. The results are robust after controlling for other drivers of trade deficit such as income, inflation, exchange rate and institutions as well as country and year fixed effects.     

Monetary policy channels in Brazil through the lens of a semi-structural model

We develop and estimate a medium-sized, semi-structural model for the Brazilian economy during the inflation targeting period. The model describes fairly well key features of the economy and allows us to decompose the transmission mechanism of monetary policy. In the baseline decomposition, the transmission mechanism is broken down into household interest rate, firm interest rate, and exchange rate channels. In addition, we carry out an alternative decomposition that allows us to evaluate the expectations channel as well. In both procedures, the household interest rate channel is the most important for explaining the response of output to a monetary policy shock. In the baseline decomposition of inflation, both the household interest rate and the exchange rate channels are the main transmission channels. However, in the alternative decomposition, the expectations channel accounts for the bulk of the inflation response.     

Monetary Policy in the Aftermath of Currency Crises: The Case of Asia

The paper evaluates monetary policy and its relationship with the exchange rate in the five Asian crisis countries. The findings are compared with previous currency crises in recent history. It is found that there is no evidence of overly tight monetary policy in the Asian crisis countries in 1997 and early 1998. There is also no evidence that high interest rates led to weaker exchange rates. The usual tradeoff between inflation and output when raising interest rates suggested the need for a softer monetary policy in the crisis countries to combat recession. However, in some countries, corporate balance sheet considerations suggested the need to reverse overly depreciated currencies through firmer monetary policy.     

Performance of inflation targeting in retrospect

Both inflation and inflation expectations declined considerably in the inflation targeting countries during the past two decades. The questions of whether this decline has actually been an outcome of inflation targeting solely and whether inflation targeting has been successful in stabilizing other macroeconomic variables though remain. This study considers these questions on the basis of 16 inflation targeting countries and 21 non-targeting ones using a difference-in-difference approach. With regard to the baseline period of 1996–1999 during which neither of the groups was implementing inflation targeting, a difference-in-difference approach was employed to assess the effects of inflation targeting on inflation, output growth, real exchange rates, inflation volatility and real exchange rate volatility during moving 4-year periods between 2007 and 2015. Our estimates suggest that inflation targeting was superior in terms of harnessing inflation as well as inflation volatility. In terms of economic growth, however, inflation targeting seems to be neutral and in terms of real exchange rates it seems not to be stabilizing, if not de-stabilizing. A hybrid version of inflation targeting, namely the conventional inflation targeting augmented by an improved capacity to deliver macro-prudence as in the post-Lehman economic climate, can therefore be viewed as the best available policy alternative for the upcoming decades.     

Capital flow reversals during the taper tantrum in 2013: causes and consequences

ABSTRACT

Quantitative easing (QE) conducted by the US Fed during 2009 Q1 to 2013 Q2 expanded capital flows into emerging economies. The possibility of tapering to reduce QE caused the taper tantrum in 2013 that was characterized by sudden capital reversals and drastic exchange rate depreciation in a subset of developing countries. In this paper we investigated factors that drove capital reversals and drastic exchange rate depreciation in the developing countries. We find that actual capital inflows during the QE periods were most responsible for capital reversals thereafter. However, we do not find evidence that capital flow reversals actually contributed to the drastic exchange rate depreciation during the taper tantrum or lowered real GDP growth afterwards. Consistent with previous studies Our findings suggest that pre-emptive measures to prevent excessive capital inflows are crucial to promote the resilience of the economy. The recent experience of Korea that introduced a series of macroprudential measures shows supporting evidence for this view.

Abbreviations: EG: Eichengreen and Gupta (2015); IFS: International Financial Statistics; PRS: Park, Ramayandi, and Shin (2016); US Fed: U.S. Federal Reserve System     

Price and liquidity puzzles of a monetary shock: Evidence from indebted African economies

Price and liquidity puzzles have been identified as two major counterintuitive findings arising from monetary shocks. We investigate their presence in eleven African countries, using a dynamic stochastic general equilibrium model designed for indebted small open-economies. Our simulations reveal that the majority of African countries report a price puzzle whereas only three countries exhibit liquidity effect. In many of the sampled countries, a positive money growth shock drives interest rates up, but consumption and output fall in contrast to the conventional view. External debt increases in response to money growth shock, exchange rate appreciates and inflation falls. Money growth shocks are transmitted to the economy through the exchange rate channel when uncovered interest rate parity condition holds. Our findings therefore appear to suggest that monetary policy in Africa should prioritize foreign debt stabilization by reacting more to output gap than to inflation.     

Monetary policy and credit cards: Evidence from a small open economy

This paper uses a unique monthly data set that covers the overall credit card usage in a small-open economy, Turkey, to investigate a possible credit channel of monetary policy transmission through credit cards. A reduced-form vector autoregression analysis is employed, where the forecast error variance decompositions are calculated for three-year windows over the period 2002–2009. It is shown that, during the recent financial crisis that has started in 2007, the monetary policy of Turkey has shifted toward focusing on output volatility and interest rate smoothing through setting short-term interest rates, while the inflation rate has been mostly affected by exchange rate movements and inflation inertia. Credit card usage has an increasing effect on inflation rates through time, requiring more policy emphasis on the credit channel through credit cards. When the effects of the credit view and the money view are compared, the former seems to be more effective on the real side of the economy, independent of the level of inflation.     

Inflation and the Exchange Rate: The Role of Aggregate Demand Elasticity

This paper examines the effect of aggregate demand elasticity on the exchange rate when inflation occurs. We discover that both the source of the inflation, whether demand-pull or cost-push, and the elasticity of aggregate demand with respect to the price level, are of consequence for the exchange rate. We obtain two primary conclusions. First, the effect on the exchange rate of cost push inflation is ambiguous and is partially determined by the price level elasticity of aggregate demand. In particular, and assuming that the two examined countries have equivalent aggregate supply elasticities, we conclude that the nation with the less elastic aggregate demand function will see its currency appreciate relative to the other. Second, demand-pull inflation results in an unambiguous increase in the exchange rate but the size of that increase is partially a function of aggregate demand elasticity. Assuming again that two countries have equivalent aggregate supply elasticities, that country with the more elastic aggregate demand will experience currency appreciation.     

Real and nominal effective exchange rates of African countries during 1971Q1–2012Q4

One of the macro variables that are included in most models is the exchange rate. Overall performance of a country’s exchange rate is measured by changes in nominal or real effective exchange rate (REER). These rates are constructed and published mostly for industrial countries by international organizations. Less developed countries have received little attention. In this article, the two rates are constructed for 21 African countries using quarterly data over the period 1971Q1–2012Q4. As an application, we use the REERs to show that even in Africa the movements of the real effective rates follow a nonlinear path.     

DSGE model-based forecasting of modelled and nonmodelled inflation variables in South Africa

Inflation forecasts are a key ingredient for monetary policy-making – especially in an inflation targeting country such as South Africa. Generally, a typical Dynamic Stochastic General Equilibrium (DSGE) only includes a core set of variables. As such, other variables, for example alternative measures of inflation that might be of interest to policy-makers, do not feature in the model. Given this, we implement a closed-economy New Keynesian DSGE model-based procedure which includes variables that do not explicitly appear in the model. We estimate such a model using an in-sample covering 1971Q2 to 1999Q4 and generate recursive forecasts over 2000Q1 to 2011Q4. The hybrid DSGE performs extremely well in forecasting inflation variables (both core and nonmodelled) in comparison with forecasts reported by other models such as AR(1). In addition, based on ex-ante forecasts over the period 2012Q1–2013Q4, we find that the DSGE model performs better than the AR(1) counterpart in forecasting actual GDP deflator inflation.     

Managing real exchange rate for economic growth: Empirical evidences from developing countries

Abstract

This article analyses macroeconomic policies capable of influencing the long-run real exchange rate (RER). In this vein, it identifies economic policy tools that can devalue RER, covering a theoretical issue neglected by the economic literature, which argues that competitive exchange rate enhances growth. After discussing the “Trilemma,” we identify those variables that could affect RER without constraining monetary policy or exchange rate regime choice. In what follows, we model the probability of achieving an undervalued (small or large) RER for a sample of 14 developing countries from 1980 to 2010 (30?years) by applying econometric techniques for discrete choice and censored data. Afterwards, we compare the results for Latin American nations with Asian ones. They suggest that competitive exchange rate requires different approaches depending on the region. Moreover, Latin American countries need to take on additional policies so that interventions in the foreign exchange market become effective.     

Asymmetric Causality Between Inflation and Uncertainty: Evidences from 33 Developed and Developing Countries

Empirical studies have provided conflicting findings about the relationship between inflation and inflation uncertainty. Thus, the direction of the causality is still questionable. The present paper is aimed to extend the existing literature using non-linearity models and asymmetric causality tests. For this purpose, the data for 33 developed and developing countries during 1988Q4-2016Q3 is used. The results showed an asymmetry in the inflation behavior which is specified by smooth transition process, as well as separating positive and negative shocks observed in causality test. The asymmetric causality between inflation and inflation uncertainty is confirmed in most countries, although the empirical evidence in favor of Cukierman-Meltzer hypothesis is found to be weaker than Friedman-Ball hypothesis.

     

Pass-through in dollarized countries: should Ecuador abandon the US dollar?

In this article, we examine the convenience of dollarization for Ecuador today. As Ecuador is strongly integrated financially and commercially with the United States, the exchange rate pass-through should be zero. However, we sustain that rising rates of imports from trade partners other than the United States and subsequent real effective exchange rate depreciations are causing the pass-through to move away from zero. Here, in the framework of the Vector Error Correction Model, we analyse the impulse response function and variance decomposition of the inflation variable. We show that the developing economy of Ecuador is importing inflation from its main trading partners, most of them emerging countries with appreciated currencies. We argue that if Ecuador recovered both its monetary and exchange rate instruments, it would be able to fight against inflation. We believe such an analysis could be extended to other countries with pegged exchange rate regimes.     

Macroeconomic Fragility and Exchange Rate Vulnerability: A Cautionary Record of Transition Economies

The interaction between the exchange rate regime and macroeconomic stabilization in several transition economies during 1990–1996 was influenced by the persistence of high inflation rates and the initial disequilibrium between the highly undervalued nominal exchange rates in relation to their purchasing power parity estimates. Policymakers generally adopted the flexible (nominal) exchange rate regimes for manipulating real exchange rates with a view to correcting the exchange rate disequilibrium and conveying inflation control signals. The rates of real appreciation were higher in the earlier years of high inflation rates. By 1996, lower inflation rates required less currency appreciations thereby reducing the negative impact of the latter on trade competitiveness. However, the persistence of unwarranted interest rate differentials, a consequence of the domination of monetary control over prudent fiscal management, and the associated inflows of foreign funds put an upward pressure on exchange rates exacerbating trade competitiveness. The transition record suggests that innovative exchange rate arrangements can provide only a brief interval during which sound fiscal discipline needs to be put in place for controlling inflation.J. Comp. Econom.,December 1998, 26(4), pp. 621–641. Columbia University, New York, New York 10027.     

The Euro Effect on Eurozone Exports

In this article, we examine the impact of the real effective exchange rate for several countries in the Euro area over the period before and after the introduction of the euro. Based on ARDL modeling techniques, we estimate the long-run and short-run relationships between exports volumes and a number of key variables, namely Real Effective Exchange Rate, weighted GDP and Output Gap. This article is particularly oriented towards the study of long-term relationships between the exchange rate and global exports performance, on the one hand; and between exchange rates and intra-European exports performance, on the other. Two measures of exchange rate are considered: a global real exchange rate to investigate the impact of exchange rates on overall exports and an intra European real exchange rate calculated to detect its effect on intra-European trade. The study shows that there is a big difference between the impact of exchange rates on exports before and after the establishment of the European Monetary Union on the one hand, and between the impacts of exchange rates on intra-European global exports on the other hand.