Convergence of Prices and Rates of Inflation*

We consider how unit‐root and stationarity tests can be used to study the convergence of prices and rates of inflation. We show how the joint use of these tests in levels and first differences allows the researcher to distinguish between series that are converging and series that have already converged, and we set out a strategy to establish whether convergence occurs in relative prices or just in rates of inflation. Special attention is paid to the issue of whether a mean should be extracted in carrying out tests in first differences and whether there is an advantage to adopting a (Dickey–Fuller) unit‐root test based on deviations from the last observation. The asymptotic distribution of this last test statistic is given and Monte Carlo simulation experiments show that the test yields considerable power gains for highly persistent autoregressive processes with ‘relatively large’ initial conditions. The tests are applied to the monthly series of the consumer price index in the Italian regional capitals over the period 1970–2003.     

Ex-post rational price approximations and the empirical reliability of the present-value relation

Excess volatility and regression tests have resulted in apparent rejections of the present-value relation when ex-post price approximations are employed. These approximations are based upon a sample terminal condition for prices, are not ergodic time-series, and do not result in statistics with readily calculable standard errors. Kleidon (1986a) has demonstrated that ex-post price approximations can subtly affect the reliability of certain volatility tests. We use a bootstrapped cointegration model to demonstrate some of these same effects in Mankiw, Romer and Shapiro's (1985) volatility statistics. The volatility statistics rarely have positive expected value in finite samples and still do not reject the presentvalue relation. Approximations based upon a ‘rolling’ terminal condition result in volatility statistics which have calculable large-sample errors, but even these standard errors greatly overstate the accuracy of volatility statisics in small samples. Regression tests of the present value relation are also affected by the price approximations.     

Testing the Structural Interpretation of the Price Puzzle with a Cost‐Channel Model*

We estimate a variety of small‐scale new‐Keynesian DSGE models with the cost channel to assess their ability to replicate the ‘price puzzle’, i.e. the inflationary impact of a monetary policy shock typically arising in vector autoregression (VAR) analysis. To correctly identify the monetary policy shock, we distinguish between a standard policy rate shifter and a shock to ‘trend inflation’, i.e. the time‐varying inflation target set by the Fed. Our estimated models predict a negative inflation reaction to a monetary policy tightening. We offer a discussion of the possible sources of mismatch between the VAR evidence and our own.     

Is there a case for higher inflation targets?

In recent years several observers have suggested that higher inflation targets might be economically beneficial. We examine the case for this, but find it unconvincing. There has been a large fall in the risk premia embedded in government bond yields over the past 25 years. Higher inflation targets would risk reversing some of these gains. We also doubt that higher inflation targets would yield the additional policy flexibility that is sometimes claimed. Nevertheless, we do detect a shift by central banks over recent years towards more tolerance of inflation risks at the margin – as seen in the adoption of ‘forward guidance’ and more ‘flexible’ inflation targeting.     

Simulation‐based tests of forward‐looking models under VAR learning dynamics

In this paper we propose a simulation‐based technique to investigate the finite sample performance of likelihood ratio (LR) tests for the nonlinear restrictions that arise when a class of forward‐looking (FL) models typically used in monetary policy analysis is evaluated with vector autoregressive (VAR) models. We consider ‘one‐shot’ tests to evaluate the FL model under the rational expectations hypothesis and sequences of tests obtained under the adaptive learning hypothesis. The analysis is based on a comparison between the unrestricted and restricted VAR likelihoods, and the p‐values associated with the LR test statistics are computed by Monte Carlo simulation. We also address the case where the variables of the FL model can be approximated as non‐stationary cointegrated processes. Application to the ‘hybrid’ New Keynesian Phillips Curve (NKPC) in the euro area shows that (i) the forward‐looking component of inflation dynamics is much larger than the backward‐looking component and (ii) the sequence of restrictions implied by the cointegrated NKPC under learning dynamics is not rejected over the monitoring period 1984–2005. Copyright © 2010 John Wiley & Sons, Ltd.     

Modified CADF and CIPS Panel Unit Root Statistics with Standard Chi‐squared and Normal Limiting Distributions

In an influential paper Pesaran (‘A simple panel unit root test in presence of cross‐section dependence’, Journal of Applied Econometrics, Vol. 22, pp. 265–312, 2007) proposes two unit root tests for panels with a common factor structure. These are the CADF and CIPS test statistics, which are amongst the most popular test statistics in the literature. One feature of these statistics is that their limiting distributions are highly non‐standard, making for relatively complicated implementation. In this paper, we take this feature as our starting point to develop modified CADF and CIPS test statistics that support standard chi‐squared and normal inference.     

Testing the New Keynesian Phillips Curve Through Vector Autoregressive Models: Results from the Euro Area*

This paper addresses the issue of testing the ‘hybrid’ New Keynesian Phillips curve (NKPC) through vector autoregressive (VAR) systems and likelihood methods, giving special emphasis to the case where the variables are non‐stationary. The idea is to use a VAR for both the inflation rate and the explanatory variable(s) to approximate the dynamics of the system and derive testable restrictions. Attention is focused on the ‘inexact’ formulation of the NKPC. Empirical results over the period 1971–98 show that the NKPC is far from providing a ‘good first approximation’ of inflation dynamics in the Euro area.     

Inflation,output and stock prices: evidence from Latin America

Research in economics and finance documents a puzzling negative relationship between stock returns and inflation rate in markets of industrialized economies. The present study investigates this relationship for the developing markets of Peru and Chile. Fama's model of linkages between inflation and real economic activity constitutes the theoretical framework of this paper. The study tests whether the negative relationship between equity returns and inflation is a result of a ‘proxy effect’, namely, a negative relationship between inflation and real economic activity. The evidence for Peru and Chile does not provide strong support for Fama's hypothesis. It is shown that the negative relationship between the real stock returns and unexpected inflation persists after purging inflation of the effects of the real economic activity. The long‐run equilibrium between stock prices and general price levels is weak, as indicated by the findings of the Johansen and Juselius co‐integration tests. However, in both economies, stock prices and general price levels seem to show a strong long‐run equilibrium with the real economic activity. These findings suggest that in the long‐run, Fama's propositions A and B are supported for Peru and Chile. The disparity between traditional regression and co‐integration test results suggest that it may be prudent to re‐examine the proxy effect in the framework of a long‐run relationship before denying its validity. Copyright © 1999 John Wiley & Sons, Ltd.     

Monetary policy in open economies: Practical perspectives for pragmatic central bankers

This paper reviews and interprets some of the key policy implications that flow from a class of DSGE models for optimal monetary policy in the open economy. The framework suggests that good macroeconomic outcomes in open economies are possible by focusing inflation targeting that is implemented by a Taylor type rule, a rule that in equilibrium is reflected in the exchange rate as an asset price. Optimal monetary policy will not be able deliver a stationary (‘stable’) nominal exchange rate – let alone a fixed exchange rate or one that remains inside a target zone – because, absent a commitment device, optimal monetary can’t deliver a stationary domestic price level. Another feature in the data for inflation targeting countries that is consistent with monetary policy via Taylor type rule is that it will tend push the nominal exchange rate in the opposite direction from PPP in response to an ‘inflation’ shock—the ‘bad news god news’ result of Clarida and Waldman (2008. Is Bad News about Inflation Good News for the Exchange Rate. In: John Campbell, (Ed.), Asset Prices and Monetary Policy, Chicago: University of Chicago Press), Clarida and Waldman (2014. Bad News About Inflation is Good News for the Nominal Exchange Rate Under Optimal Monetary Policy: DSGE Theory and a Decade of Empirical Evidence). This is so even though in the long run of these models the nominal exchange rate must in expectation obey PPP.     

The Political Economy of Low Inflation

What are the politics of inflation? This question is usually raised solely when inflation rates are high. All levels of inflation, however, high and low, are the outcome of political conflicts. But no current approach to the study of inflation — sociological, neoclassical, modern political economy — adequately captures the full range of political issues at stake, and this leads to problems for both theory and policy. This paper critiques the existing perspectives on inflation and then focuses on three theoretical issues raised by those critiques: the economic costs of inflation; the concept of monetary neutrality from economic and political perspectives; and the importance of disaggregating economic growth statistics. Finally, the paper introduces and explores a contending approach to the analysis of the political economy of inflation: a ‘micro‐politics’ perspective. This approach is the only one to address the politics of low inflation, which is of great significance for contemporary political economy.     

Forecasting the Real Exchange Rate

This brief examines the historical relationship between exchange rates and relative inflation rates for a group of major industrial countries. It establishes the concept of the ‘real exchange rate’ and the ‘productivity-adjusted real exchange rate’ (PARE) as essential in understanding these relationships and projecting them into the future. It puts the discussion into the context of company decision making, as one important factor in the rate of return likely to accrue from different methods of supplying an overseas market. Differences in productivity between countries explain the divergences in prices of ‘non-traded goods’. To give a simple example, a haircut costs much more in New York than in Madrid since high US wages reflect high productivity which does not apply in many parts of the service sector. These differences rule out the acceptance of the over simple ‘purchasing power parity’ approach which assumes that exchange rates will settle at a point where all prices (in terms of a common currency) are the same everywhere, or move together. Even after account has been taken of differences in productivity growth, productivity-adjusted real exchange rates (PARE) - though reasonably stable - can still show some deviations, or ‘blips’. The ‘blip’ may occur because of rapid changes in the actual exchange rate or in domestic prices, in which case it is likely to prove temporary and the PARE rate will tend to adjust back to its normal level. But it may come from major structural changes, in which case PARE will be altered permanently within definable limits. A way of recognising the different categories of ‘blip’ is suggested in the brief. The PARE framework is then used to provide a guide to UK businesses who are concerned to calculate the future sterling value of foreign currency sales or, more generally, to estimate their competitiveness in supplying specific export markets. (The method used would apply equally well to other countries.) This is done by showing step-by-step the forecasting procedure to compute sterling's effective exchange rate to 1981 on assumptions concerning respective rates of inflation, monetary policy and the impact of North Sea oil. The computation shows that a sustained period of exchange rate stability is possible for the UK, even if UK inflation rates remain significantly above the world level for the next two years.     

The impact of the COVID-19 pandemic on business expectations

We document and evaluate how businesses are reacting to the COVID-19 crisis through August 2020. First, on net, firms see the shock (thus far) largely as a demand rather than supply shock. A greater share of firms report significant or severe disruptions to sales activity than to supply chains. We compare these measures of disruption to their expected changes in selling prices and find that, even for firms that report supply chain disruptions, they expect to lower near-term selling prices on average. We also show that firms are engaging in wage cuts and expect to trim wages further before the end of 2020. These cuts stem from firms that have been disproportionally negatively impacted by the pandemic. Second, firms (like professional forecasters) have responded to the COVID-19 pandemic by lowering their one-year-ahead inflation expectations. These responses stand in stark contrast to that of household inflation expectations (as measured by the University of Michigan or the New York Fed). Indeed, firms’ one-year-ahead inflation expectations fell precipitously (to a series low) following the onset of the pandemic, while household measures of inflation expectations jumped markedly. Third, despite the dramatic decline in firms’ near-term inflation expectations, their longer-run inflation expectations have remained relatively stable.     

The impacts of benefit plans on employee turnover: a firm-level analysis approach on Taiwanese manufacturing industry

Employee turnover is a serious problem and the question of how to retain highly talented and valued people is very important. Previous employee turnover studies were mostly focused on the individual level but rarely from the standpoint of the business or firm. This study examines the impacts of four kinds of benefit plans on firm-level employee turnover issues, namely, retirement fund, pension, severance pay and fringe benefit. The present study uses the Census Bureau Employment Movement Survey of the Directorate General of Budget, Accounting and Statistics in Taiwan. The two models used to examine the overall manufacturing industry were: (1) the inducement model which tests the ‘with or without’ effect; and (2) the investment model which tests the ‘the more the better’ effect. Results reveal that, with respect to the firm's employee turnover rate, retirement fund and fringe benefits are negative while severance plans are significantly positive. These results are consistent with the transaction costs theory that total expenditure on these plans to retain employees (bureaucratic cost) is less than the market arrangements (transaction cost). In addition, the impact of pension plans is negative in respect of employee turnover in larger or more highly educated firms, but positive in firms with a lower educational level. Moreover, the firm size is negative while the firm's average employees' educational level is positive with respect to the workforce leaving their jobs. These results are consistent with the perspective of resource-based theory and human capital theory. Incidentally, this study also reveals insignificant differences between the ‘with or without’ effect and the ‘the more the better’ effect existing as a sub-group industry rather than across the entire industry.     

Exchange Rates,Non-Traded Goods and the Terms Of Trade: An Empirical Application for New Zealand

This article formulates and tests for New Zealand a model of exchange rate determination focusing on non-tradeable goods and terms-of-trade shifts. We emphasize the equilibrium properties of this framework and, in this context, estimate an error correction model where adjustment in response to deviation from equilibrium is an important determinant of short-run exchange rate movements. We estimate the model using a new data series on the supply of non-tradeable goods. The model has desirable empirical characteristics, including a plausible error correction equation, strong support for cointegration and rapid convergence to the long-run equilibrium. Moreover, a variety of diagnostic statistics, including parameter stability tests andout-of-sample forecasting performance, indicate the equation is a parsimonious representation of the data. These results provide considerable support for the emphasis on ‘real’ determinants of nominal exchange rates, in this case fluctuations in non-traded goods supply and terms-of-trade.     

Testing for unit roots in time series models with non-stationary volatility

Many of the key macro-economic and financial variables in developed economies are characterized by permanent volatility shifts. It is known that conventional unit root tests are potentially unreliable in the presence of such behaviour, depending on a particular function (the variance profile) of the underlying volatility process. Somewhat surprisingly then, very little work has been undertaken to develop unit root tests which are robust to the presence of permanent volatility shifts. In this paper we fill this gap in the literature by proposing tests which are valid in the presence of a quite general class of permanent variance changes which includes single and multiple (abrupt and smooth-transition) volatility change processes as special cases. Our solution uses numerical methods to simulate the asymptotic null distribution of the statistics based on a consistent estimate of the variance profile which we also develop. The practitioner is not required to specify a parametric model for volatility. An empirical illustration using producer price inflation series from the Stock–Watson database is reported.     

The Dollar, the Oil Price and Policy Divergence

There is currently a clear divergence of policy between the United States, Japan and Germany. With the US in recession and concern growing over the severity of the slump, interest rates have been cut in a move to revive the economy. In contrast Japan and Germany are both experiencing strong growth and monetary policy remains tight to combat inflation. This divergence was seen most clearly when the Federal Reserve Board lowered its discount rate to 6 per cent on 1 February, the day after the Bundesbank had raised its Lombard rate to 9 per cent. With G7 increasingly concerned about domestic factors, less emphasis is placed upon stable exchange rates and as a result the dollar is at an all-time low. The last two G7 communiqués have stressed ‘stability oriented monetary policies’, an ambiguous phrase which fails to define ‘stability’ either in terms of exchange rates, inflation or growth. Thus both the German and Japanese policy of high interest rates to reduce inflation and low US interest rates aimed at stimulating the economy can be termed as ‘stability oriented’. This analysis focuses on these divergent policy responses in two alternative scenarios to the world forecast we presented last month. The first scenario considers what might happen if the Federal Reserve Board were to stimulate the US economy by further cuts in interest rates, whilst Japanese and German rates were unchanged in the face of inflationary pressures. This case may be relevant if the recent US loosening of monetary policy is not sufficient to encourage growth because of a ‘credit crunch’, so that a more expansionary policy is required by the Fed. As a consequence, policy diverges further and the dollar weakens. The second scenario focuses upon a reduction in inflationary pressures in Japan and Germany brought about by an oil price fall. In this case we assume that US policy is already loose enough to avoid a prolonged recession, but that German and Japanese monetary policy is relaxed as inflationary forces recede. In this case policies converge. Each scenario thus concentrates on one of !he two features which are causing the policy divergence amongst G3 countries: recession in the US, inflation in Germany and Japan.     

Economic Outlook 1991–1995: The London Business School with Gower Publishing: Forecast Release: THE CHANCELLOR'S ECONOMIC ADVICE

Within the last month the Chancellor has made two important speeches on macroeconomic policy. The first, to Surrey businessmen in June, pledged the UK to the French route to a ‘virtuous circle of low inflation, rising competitiveness and increasing market share’; the second, in July to the European Policy Forum, vigorously defended his present policy against the alternatives, which he dismissed as ‘illusory or destined to fail’, of devaluation or cutting interest rates. On both occasions Mr. Lamont placed the permanent conquest of inflation at the centre of his policy, arguing that holding sterling at its present central parity of DM 2.95 is the only way to achieve this objective. In his view the consequence of any of the alternative proposals would be ‘either higher interest rates, higher inflation, or most likely both’. In this Forecast Release we consider these claims and the economic advice on which it is based. On the latter we would surmise that the thrust of the advice which Mr. Lamont is receiving is that he has the opportunity to deliver a sustainably low inflation rate and that this requires a stable pound within the ERM. The alternatives involve a sterling devaluation which, no matter how obtained, would obstruct the goal of permanently low inflation in return for only transient benefits on output and unemployment. But the price of defeating inflation has been high and is not yet fully paid. Moreover the goalposts have been moved: to reach the French position on competitiveness, which underpins their gains in market share and which has taken the best part of a deeade to achieve, requires a still better inflation performance on the part of the UK and while this is being achieved, adjustment costs will persist. It is partly in defence of his own policies and partly in an attempt to moderate the already-high adjustment costs that Mr. Lamont has adopted a more combative stance. His advice is that to compete with Europe, we cannot award ourselves pay increases far in excess of European levels, indeed we need a period of below-average pay rises.     

Simple and powerful GMM over-identification tests with accurate size

Based on the series long run variance estimator, we propose a new class of over-identification tests that are robust to heteroscedasticity and autocorrelation of unknown forms. We show that when the number of terms used in the series long run variance estimator is fixed, the conventional J statistic, after a simple correction, is asymptotically F-distributed. We apply the idea of the F-approximation to the conventional kernel-based J tests. Simulations show that the J^∗ tests based on the finite sample corrected J statistic and the F-approximation have virtually no size distortion, and yet are as powerful as the standard J tests.     

A fractional cointegration analysis of Fisher hypothesis: evidence from Turkey

This paper examines the validity of Fisher hypothesis in Turkey over the period from 1990:01 through 2010:03 by using cointegration and fractional cointegration approaches. The findings from Engle and Granger cointegration test indicate that inflation and nominal interest rate series are cointegrated. Since the conventional cointegration tests do not provide strong evidence on the long run relationship, we also use fractional cointegration definition suggested by Cheung and Lai (J Bus Econ Stat 11:103–112, 1993) which requires only a mean reverting (d < 1) relationship between the series. The results from fractional cointegration tests based on GPH and Robinson methods show that inflation and nominal interest rate series are fractionally cointegrated. These findings support the validity of the Fisher hypothesis in Turkey.     

广义Breitung非参数单位根检验研究——基于平稳假设下序列长期方差一致估计的分析

Breitung检验中生成序列的误差项的自相关会影响有限样本性质。本文用平稳假设下序列长期方差的一致估计量作为统计量的分母对其进行了修正。给出了修正后的统计量及其渐近理论,并对修正前后的有限样本性质进行了仿真。结果显示,修正后统计量概率密度的左偏有所减少;当误差项有自相关时,修正后检验的水平扭曲有所改进;当样本较小时,随误差项自回归(移动平均)系数或序列自回归系数的增加,修正后检验的势逐渐大于Breitung检验的势。