Threshold Effects of Inflation on Economic Growth: Is Africa Different?

This study examines nonlinearities in the inflation-growth nexus in Africa. The study employs a novel dynamic panel threshold regression method developed by Kremer et al. [(2013). Inflation and growth: New evidence from a dynamic panel threshold analysis. Empirical Economics, 44, 861–878. doi:10.1007/s00181-012-0553-9] that extends Hansen’s [(1999). Threshold effects in non-dynamic panels: Estimation, testing, and inference. Journal of Econometrics, 93, 345–368. doi:10.1016/S0304-4076(99)00025-1] non-dynamic panel threshold model as well as Caner and Hansen [(2004). Instrumental variable estimation of a threshold model. Econometric Theory, 20, 813–843. doi:10.1017/S0266466604205011] cross-sectional threshold model to deal with potential endogeneity problems. The findings of this study confirm a non-linear relationship between inflation and economic growth in Africa. More specifically, the results show that the inflation threshold values are 6.7% for the whole sample, 9% for the sub-sample of low-income countries and 6.5% for middle-income countries. The regression results suggest that relatively lower level of inflation appears to be in favor of higher economic growth only in African middle-income countries. However, inflation rate beyond a certain threshold is more likely to be detrimental to economic growth for all the cases. These results are robust by considering additional control variables and using three-year averages of the data. The findings of this study may be useful to African monetary policymakers as they decide on inflation targets to adopt to avoid the detrimental effects of high inflation while reaping the growth benefits of low inflation.     

Term Spreads,Forward Rates and Yield Curve Forecasts

The expectations hypothesis contends that long rates should equal expected forthcoming average short rates. The spread between long and short rates should therefore forecast changes in short rates. In addition, forward rates should anticipate future spot rates. We present econometric evidence for the Euro area in the period from September 2004 to August 2018. In our sample, term spreads are negatively correlated to subsequent interest rate changes. The difference between forward and spot rates is conversely positively correlated to ensuing spot rate changes. Further regression analysis shows, that nominal interest rates do not have predictive properties for future inflation. A vector autoregression analysis whilst revealing medium term overconfidence of Euro area investors, suggests that the propositions of the expectations hypothesis should hold over relatively long periods of time.     

Inflation Dynamics in the Euro Area and the Role of Expectations

This paper examines the empirical performance of the New Keynesian Phillips curve and its hybrid specification in the euro area. Instead of imposing rational expectations, direct measures, i.e. OECD forecasts, are used as empirical proxies for economic agents’ inflation expectations. Real marginal costs are proxied by three alternative measures. The results suggest that once the rational expectations hypothesis is relaxed and directly measured expectations are used, the European inflation process can be modeled using the forward-looking New Keynesian Phillips curve. However, when allowing for possible non-rationalities in expectations, inflation can be modeled more accurately by the hybrid Phillips curve with the additional lagged inflation term. In this approach, output gap turns out to be at least as good as labor income share as a proxy for real marginal cost. Moreover, the inflation process seems to have become more forward-looking in the recent years of low and stable inflation.The views expressed are those of the author and do not necessarily reflect the views of the Bank of Finland. Special thanks are due to the editor, two anonymous referees, Juha Tarkka, Jouko Vilmunen and Matti Virén for useful comments. I am also grateful to David Mayes and Geoffrey Wood for helpful suggestions and to Heli Tikkunen for excellent research assistance. For their constructive comments, I would also thank participants in the conference on the Eurosystem Inflation Persistence Network at the ECB, which was held in Frankfurt in December 2003.     

Estimating inflation compensation for Turkey using yield curves

Inflation compensation derived from nominal and real bond yields contains market based, real time information regarding the inflation expectations and the pricing of inflation risks. In this study, we calculate inflation compensation for Turkey by using nominal and real yield curves. The findings of event study analysis on inflation compensation indicate that changes in the term structure of inflation compensation contain information regarding the credibility of monetary authority. Moreover, we find that, at daily frequency, liquidity conditions have no significant effect on inflation compensation and hence the effects of events such as monetary policy decisions and inflation surprises on inflation compensation can be attributed mainly to changes in inflation expectations and pricing of inflation uncertainty.     

Trend breaks and the fisher hypothesis in canada and the United States

Using the sequential estimation methodology developed by Banerjee, Lumsdaine and Stock (Journal of Business and Economic Statistics, 10(3), 271–87, 1992), Zivot and Andrews (Journal of Business and Economic Statistics, 10(3), 251–70, 1992) and extended by Lumsdaine and Papell (Review of Economics and Statistics, 79(2), 212–18, 1997), empirical evidence is found consistent with the hypothesis that the 90-day Treasury Bill rate and the inflation rate in Canada and the US are stationary around a deterministic trend with two breaks. When the breaks are filtered out, the data is consistent with partial long-run adjustment of the nominal interest rate to an inflation shock, but not of the size predicted by the Fisher Effect.     

Assessing the predictive power of financial spreads in the euro area: does parameters instability matter?

In the empirical literature there is wide consensus that financial spreads cannot constitute a broadly based assessment on future output growth and inflation because the bivariate estimated regressions are not stable over time and lead to relatively poor out-of-sample forecasting performance (e.g. J Econ Liter 41:788–829, 2003). This conclusion arised for the USA, as well as for several European countries. In this paper we check whether the marginal predictive content of some financial spreads (the slope of the yield curve, the reverse yield gap and the credit spread) for macroeconomic forecasting in the euro area can be recovered using techniques taking into account potential parameters instability. We set up a quarterly Bayesian vector autoregression model with time-varying coefficients, comprising both target variables, as well as other monetary policy indicators, to serve as a benchmark. Then, the properties of the spreads as leading indicators are assessed by augmenting this benchmark BVAR with the spreads, one at a time. We find time variation of the coefficients to be a relevant issue in our model, especially for forecasting output growth, but financial spreads continue to have no or negligible marginal predictive content for both output growth and inflation. Overall, our results confirm that there is no ready-to-use financial spread that can replace an encompassing multivariate model for the prediction of target variables in the euro area.      

The Bundesbank's Inflation Policy and Asymmetric Behavior of the German Term Structure

The paper analyzes the influence of the Bundesbank's inflation targeting policy on the behavior of the spread between long‐term and short‐term German interest rates. The term spread is considered to be a key indicator of future inflation and economic activity. The application of a momentum threshold autoregressive cointegration model enables the authors to study the adjustment process of the spread toward equilibrium in greater detail than heretofore possible, and permits relaxation of the linear and symmetric adjustment assumption underlying conventional cointegration and error correction investigations on the expectations hypothesis. The empirical findings are consistent with the hypothesized asymmetric adjustment behavior of the spread and can be explained by the Bundesbank's inflation targeting policy during the period from 1975 to 1998.     

Nonstationarity,cointegration and structural breaks in the Australian term structure of interest rates

This article examines the unit-root property of the Australian short- and long-term interest rates using unit-root tests that accommodate a single or two breaks under the null and/or alternative hypothesis. Two breaks in interest rates are found to coincide with the 1982/83 and 1990/91 recessions or the 1993 inflation targeting period. We further investigate the implications of these structural breaks on the cointegrating relationship implied by the single, linear expectations hypothesis of the term structure of interest rates. While there is evidence that the data are consistent with the expectations hypothesis at the shorter end of the term structure, breaks in interest rates generate a shift in the cointegrating relationship, thus altering the information content of the term structure. Failing to account for a regime shift in the cointegration regression, the data erroneously supports the expectations hypothesis at the longer end of the term structure. These results have profound implications for policy makers who may inadequately exploit the information content of the term structure to predict future changes in inflation.     

An Application of Quah and Vahey’s SVAR Methodology for Estimating Core Inflation in India: A Note

Inflation, calculated as year-on-year per cent change in general price level, represents a combined effect of several types of price changes. The monetary authorities primarily focus to track that part of inflation, which can be effectively monitored and controlled using various monetary instruments. This persistent component of inflation is termed as ‘Core Inflation’, which possesses long-run properties as well as predictive power to forecast inflation. This paper makes use of Quah and Vahey’s definition of core inflation as that component of headline inflation, which has no impact on output in medium to long run and estimates it by placing restrictions on vector auto regression system with inflation and output growth. The analysis is based on monthly data from April 1995 to January 2009. Empirical results showed that in India, during 2006 and 2007, the inflation process was stronger than what headline inflation figures actually depicted and in 2008 the inflationary process has tended to be somewhat weaker than what was observed in headline inflation.

     

Inflation expectations in Turkey: learning to be rational

Turkey implemented an ambitious restructuring of the economy in the past several years, including the adoption of inflation targeting along with a floating exchange rate regime. Inflation came down from almost triple digits to single digits between 2001 and 2005. This particular episode of the Turkish economy sets a genuine case study for investigating the possible changes in the behaviour of inflation expectations upon a regime shift. Accordingly, this study analyses inflation expectations in Turkey, focusing especially on the post-2001 transition phase. We first conduct classical tests of unbiasedness and efficiency using aggregate survey data between August 2001 and October 2007 to get a statistical benchmark for rationality; we find that classical tests reject full rationality hypothesis for all series except next month's Consumer Price Index (CPI) inflation expectations. Then, we carry out Time-Varying Parameter (TVP) estimates based on a Kalman filter to see how the coefficients in the classical test equations evolve over time. This framework allows us to see whether there is convergence to rationality in terms of unbiasedness and efficiency. We find that forecast performance has improved through time, as the coefficients on the test equations shows movement towards values implied by unbiasedness and efficiency hypotheses, supporting the learning hypothesis.     

The expectations hypothesis of the term structure of interest rates and monetary policy: some evidence from Asian countries

This article outlines a panel data approach to modelling the term structure of interest rates in the short and in the long run. We find robust evidence supporting the expectations hypothesis of the term structure (EHTS) for a small sample of Asian emerging markets. Furthermore, we detect some relevant differences in the transmission mechanism of monetary policy, and the existence of a McCallum (2005) rule (no exogeneity of monetary policy to the yield curve) in some countries. Finally, we document the influence of an international global factor (i.e. a time-varying global risk premium) on the yield curve, while local country-specific factors are not statistically significant.     

From profit margins to income distribution: Joan Robinson's odyssey from marginal productivity theory

The point of departure for this paper is a 1941 Note on profit margins co-authored by Joan Robinson and Nicholas Kaldor that remained unpublished until 2000. Robinson's reviews of Henry Clay's The Problem of Industrial Relationships, Bresciani Turroni's The Economics of Inflation, and Roy Harrod's Towards a Dynamic Economics, along with her 1965 Cambridge Inaugural Lecture, may be interpreted as analogous documents that develop her critique of neoclassical wage theory and identify the money wage as the economy's ‘key’ price. These publications were critical steps toward the wage mark-up hypothesis and Post-Keynesian support of incomes policy to contain inflation. Robinson's Harrod review anticipated her later ideas about economic growth. With Kalecki's notion of ‘the degree of monopoly’ and her own concept of neo-mercantilism (from the Inaugural Lecture), these themes are nascent in the Robinson–Kaldor Note on profit margins.     

Market‐Based Measures of Monetary Policy Expectations and Their Evolution Since the Introduction of the Euro

The paper considers the relation between monetary policy expectations and financial markets in the case of Europe. A number of money market instruments are compared, with the result that the 1‐month forward interest rates extracted from the Libor yield curve has the best prediction power of the future monetary policy path. These forward rates have been used to study the evolution of market expectations regarding the monetary policy of the European Central Bank (ECB). The sharp increases and the following decreases in interest rates during 2000–2001 have reduced the predictive power of money market instruments, but smoother management of interest rates and better communication from the ECB has helped to improve the forecasting power of money market instruments.     

OPTIMAL MONETARY POLICY WITH THE STICKY INFORMATION MODEL OF PRICE ADJUSTMENT: INFLATION OR PRICE‐LEVEL TARGETING?

I investigate the optimal monetary policy in a New Keynesian macroeconomic framework with the sticky information model of price adjustment. The model is solved for optimal policy, and welfare implications of three alternative monetary policy regimes under this optimal policy are compared when there is a cost‐push shock to the economy. These monetary policy regimes are the unconstrained policy, price‐level targeting and inflation targeting regimes. The results illustrate that optimal policy depends on the degree of price stickiness and the persistence of the shock. Inflation targeting emerges as the optimal policy if prices are flexible enough or the shock is persistent enough. However, the unconstrained policy or price‐level targeting might be preferable to inflation targeting if prices are not very flexible and the shock is not very persistent. The results also show that as prices become more flexible, the welfare loss usually gets bigger.     

Measuring inflation expectations: a survey data approach

Measures of expected inflation from consumer surveys are derived using a modification of the Carlson-Parkin probability approach, which does not assume unbiasedness of expectations, makes use of survey data on expected future as well as perceived past price developments and allows for time varying response thresholds. We apply this method to the normal, central-t and noncentral-t distributions, thereby investigating the effects of nonnormal peakedness and asymmetry. We find that the effects on expected inflation of the former are small and of the latter are substantial, without increasing the accuracy of the expectations, however. Expected and actual inflation show substantial persistence, and, for most of our expectations measures, are cointegrated. Furthermore, the forecast error is stationary, implying weak-form rationality. The co-movement of currently observed expected inflation measures and the unobserved 12-months-ahead inflation rate is of interest for policy makers, for example in the direct inflation targeting strategy. Notwithstanding this, caution is warranted in using them as information variables because the inflation expected by consumers is no causal determinant of actual future inflation.     

The information content of the term structure: Evidence for Germany

This paper studies the usefulness of spreads between interest rates of different maturities as indicators of future inflation and real interest rates in Germany, using monthly data starting in 1967∶1. The central results are twofold. First, the interest rate spreads considered contain considerable information about future changes in inflation, but no information about the time path of real interest rates. Second, the medium-term segment of the yield curve (spreads between 6 and 2 year rates, for instance) appears to be the most informative for future inflation. These results are similar to those obtained by Mishkin (1990b) and Jorion and Mishkin (1991).     

Money and inflation: a reply

The aim of this note is to reply to John Gibson's comments in the current issue of this journal on my paper titled ’Money and inflation: the case of western developed countries, 1960–80’ published in Applied Economics 1990, 22 863–9.     

An Economic Definition of the Middle Class

The concept of a middle class is prevalent in both common parlance and the social sciences; concern is frequently expressed that the middle class is shrinking, and politicians often position themselves as champions of the middle class. Yet the phrase “middle class” is extremely ambiguous; no consensus exists on either the upper bound or the lower bound separating the middle class from other classes. The present paper employs the government’s official poverty line as the demarcation between the poor and the middle class, and develops an equivalent distinction to separate the middle class from the wealthy. Based on the new definition, the paper provides some rough empirical estimates of the size of the American middle class over the 1989–2004 period.

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.     

The predictive power of yield spread: evidence from wavelet analysis

This paper examines whether the spread between long- and short-terminterest rates contains information about future economic activity in India. Using the yields on securities with maturities ranging from three months to ten years, we construct five different yield spreads at shorter end, longer end, and policy relevant area of the yield curve. We study the predictive power of each of these spreads for output growth within aggregate and time scale framework using wavelet methodology. We find that predictive power holds only at lower frequencies for the spreads which are constructed at shorter end and policy relevant areas of yield curve. However, spreads which are constructed at the longer end of the yield curve do not seem to have predictive information for output growth.