Sticky prices and moderate inflation

Recent evidence shows that there is great heterogeneity in the price setting frequency across sectors, and that those changing prices frequently do so even under low inflation. What happens to price setting strategies of sticky price goods under moderate inflation? We built a dataset of monthly newspaper and magazine prices for Colombia, for the period 1960–2005, an exceptional example of prolonged moderate inflation. Within this macroeconomic scenario, and the novel database, we study the frequency of price adjustment, the relative importance of time- and state-dependent theories, and their evolution as inflation declined from moderate rates to single digits.     

Globalization, the output-inflation tradeoff and inflation

This paper provides comprehensive evidence on the relation between inflation and globalization, defined here as trade and financial openness, using a large cross-section of 91 countries over the period 1985-2004. We establish two main empirical regularities: both higher trade and financial openness (i) reduce central banks’ inflation bias, yielding lower average inflation and (ii) are associated with a larger output-inflation tradeoff. This evidence is at odds with the standard Barro-Gordon framework, which would require globalization to have a negative effect on the output-inflation tradeoff to yield lower equilibrium inflation, but it is consistent with a recent strand of new Keynesian models emphasizing the role of imperfect competition and nominal rigidities. Our findings also support the relevance of the time-inconsistency hypothesis, which underlies the theoretical models predicting a relation between globalization and inflation. For the OECD subsample, however, we do not find an effect of openness on inflation (the output-inflation tradeoff), suggesting that these countries have created an institutional framework for central banks that eliminates distortions due to the time-inconsistency problem.     

Currency substitution,inflation, and welfare

Currency substitution affects the mapping between social welfare and inflation by altering the underlying money demand function and influencing interest rates. In order to explore the essence of this effect, I build a model with working capital under which foreign currency is substituted with the less liquid components of domestic money. The framework closely mimics the actual pattern of currency substitution across varying rates of inflation and enables the study of an additional channel that works through the impact of currency substitution on interest rates. It is found that there is a threshold inflation rate, which turns out to be 44% under baseline calibration, below which currency substitution decreases welfare and vice versa. A practical implication is that, at inflation rates lower (greater) than the threshold, the potential welfare gains from disinflation to a near-zero inflation rate are higher (lower) if there is currency substitution than otherwise.     

Dollarization and financial integration

How does a country's exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government responds to shocks by adjusting monetary policy and foreign borrowing. Sovereign borrowing is subject to endogenous limits, which ensure repayment when the default punishment corresponds to financial autarky. Dollarizing implies renouncing monetary policy, but can make access to international debt markets more valuable, thereby loosening borrowing constraints. This mechanism linking dollarization to financial integration is consistent with observed declines in spreads on foreign-currency debt in countries adopting the dollar or the euro.     

Macroeconomic dynamics in Macedonia and Slovakia: Structural estimation and comparison

This paper estimates a structural macroeconomic model using data for Macedonia and Slovakia to characterize possible challenges Macedonia can face concerning macroeconomic stabilization during its transition process. A comparison of the estimated model parameters suggests that, in Slovakia, the output gap is less sensitive to real interest rate movements and prices experience greater inertia. The estimated monetary policy reaction functions show Macedonia and Slovakia as inflation targeters, with Macedonia as the more conservative one, despite its officially applied exchange rate targeting regime. The differences in the estimated parameters imply differing transmission mechanisms for Macedonia and Slovakia. Consequently, the variance of domestic variables in Slovakia is most influenced by monetary policy shocks, while there is no single dominating shock explaining the volatility of Macedonia's macroeconomic variables. The exchange rate shock, the monetary policy shock and the demand shock are jointly important in determining the volatility of Macedonia's variables. The model simulations indicate that Macedonia experiences lower output gap and inflation volatility than Slovakia. This comes, nevertheless, at the cost of higher interest rate and real exchange rate volatility in Macedonia, which could be an indication of more volatile financial markets with possible negative implications for financial stability.     

Fiscal Shocks and the Current Account in the Redux Model: Evidence from the Italian Economy

The main goal of this paper is to study the effects of fiscal policy on the current account in the Italian economy through the analysis of one of the most innovative intertemporal models of recent years, the Obstfeld–Rogoff Redux model. The author proposes an innovative econometric approach to the model, based on the estimation of the microeconomic parameters that appear in its fundamental equations. The estimated parameters are used to empirically determine the multipliers that, according to the theory, connect permanent and temporary variations in public expenditure to the current account. Estimation is carried out on a dynamic extension of the original model, which has been developed modifying the first order conditions system of the maximization problem. Finally, the author provides a comparison between the results obtained and the actual dynamics of the Italian current account balance.     

Adjustment within the euro. The difficult case of Portugal

In the second half of the 1990s, the prospect of entry in the euro led to an output boom and large current account deficits in Portugal. Since then, the boom has turned into a slump. Current account deficits are still large, and so are budget deficits. This paper reviews the facts, the likely adjustment in the absence of major policy changes, and examines policy options.     

Smoothing sudden stops

Emerging economies are often exposed to sudden shortages of international financial resources. Yet domestic agents do not seem to take preventive measures against these sudden stops. We highlight the central role played by the limited development of ex ante (insurance) and ex post (spot) domestic financial markets in generating this collective undervaluation of international resources. We study several policies to counteract the external underinsurance. We do this by solving for the optimal mechanism given the constraints imposed by limited financial development, and then considering the main financial policies—in terms of the model and practical relevance—that implement this solution.     

Budget deficits and inflation feedback

This paper reinterprets the mixed evidence of the relationship between budget deficits and inflation in high inflation economies. The main finding is that recurrent outbursts of extreme inflation in these economies can be explained by a certain hysteresis effect associated with public finance. This interpretation meets the evidence that dramatic shifts between regimes of moderately high and extremely high (hyper-) inflation often occur without visible deterioration in public finance or abrupt shifts in fiscal or monetary policies. The existence of this hysteresis effect is explicitly explained by the action of two mechanisms: the arithmetic associated with the wrong side of the inflation tax Laffer curve and the Patinkin effect (the reverse of the much oftener cited Olivera-Tanzi effect). It is also shown that the division of the operational budget deficit into the part that is subject to negative inflation feedback and the part that is inflation-proof has implications for both the discussion of the inflationary consequences of budget deficits and the design of stabilization policy.     

International transmission of environmental policy: A New Keynesian perspective

In this paper we examine the international transmission of environmental policy using a New Keynesian model of the global economy. We first consider the case in which the quality of the environment affects utility, but not productivity. This allows us to look at the trade-off between environmental quality and output. We then consider the case in which the quality of the environment increases productivity but does not affect utility. Our main results show that in both cases a unilateral implementation of a more stringent environmental policy by the domestic country raises foreign welfare under a benchmark parameterization. Our modeling strategy allows an analysis of how nominal rigidities interact with the implementation of environmental reforms, by allowing the domestic country to shift, through exchange rate depreciation, parts of the costs of more stringent environmental policies to the foreign one.     

Financial systems and the cost channel transmission of monetary policy shocks

We study the role of financial systems for the cost channel transmission of monetary policy in a calibrated business cycle model. We characterize financial systems by the share of bank-dependent firms and by the degree of the pass-through from policy to bank lending rates, for which we provide empirical estimates for the euro area and the US. For plausible calibrations of the dynamics of the lending rate we find that the cost effects directly related to interest rate movements have only a limited effect on the transmission mechanism.     

Money, credit and banking

In monetary models where agents are subject to trading shocks there is typically an ex post inefficiency since some agents are holding idle balances while others are cash constrained. This problem creates a role for financial intermediaries, such as banks, who accept nominal deposits and make nominal loans. In general, financial intermediation improves the allocation. The gains in welfare come from the payment of interest on deposits and not from relaxing borrowers’ liquidity constraints. We also demonstrate that when credit rationing occurs increasing the rate of inflation can be welfare improving.     

On the relevance of exchange rate regimes for stabilization policy

This paper assesses the relevance of the exchange rate regime for stabilization policy. Using both fiscal and monetary policy, we conclude that the exchange rate regime is irrelevant. This is the case independently of the severity of price rigidities, independently of asymmetries across countries in shocks and transmission mechanisms. The only relevant conditions are on the mobility of labor and financial assets. The results can be summarized with the claim that every currency area is an optimal currency area. However, with labor mobility or tradable state-contingent assets, additional policy instruments would be required to establish the irrelevance result.     

An experimental investigation of wage taxation and unemployment in closed and open economies

We investigate experimentally the economic effects of wage taxation to finance unemployment benefits for a closed economy and an international economy. The main findings are the following. (i) There is clear evidence of a vicious circle in the dynamic interaction between the wage tax and unemployment. (ii) Employment is boosted by budget deficits but subsequent tax rate adjustments to balance the budget lead to employment levels substantially lower than theoretically predicted. (iii) A sales risk for producers due to price uncertainty on output markets appears to cause a downward pressure on factor employment. For labor the wage tax exacerbates this adverse effect.     

Wage bargaining and inflation

This paper investigates the issue of time inconsistency of monetary policy in a game with perfect information and infinite repetitions. The private sector is described by a wage negotiation process between a labour union and a firm. Unlike in the standard literature, the model has the feature that as the distortion of the economy gets larger, namely as the bargaining power of the union increases, the reputational equilibrium with low inflation becomes more likely to occur. This finding is consistent with the observation that higher levels of the labour cost are not typically associated with higher levels of inflation.     

Real and nominal effects of monetary policy shocks

Abstract.  We employ the identification scheme of Kahn, Kandel and Sarig (2002) to analyse the impact of Canadian monetary policy on ex ante real interest rates and inflationary expectations. First, we decompose nominal interest rates into ex ante real rates and inflationary expectations using the methodology of Blanchard and Quah (1989) . Then we estimate a recursive VAR model with innovations in a monetary aggregate and the overnight target interest rate as alternative measures of monetary policy shocks. We find that a negative policy shock raises both nominal and ex ante real interest rates, lowers inflationary expectations and real industrial output, and appreciates the Canadian dollar.     

Search, money, and inflation under private information

I study monetary exchange and inflation when buyers have private information about their willingness to pay for certain goods. Introducing imperfect information in the Lagos-Wright [A unified framework for monetary theory and policy analysis, J. Polit. Economy 113(3) (2005) 463-484] economy shows that the existence of monetary equilibrium is a more robust feature of the environment. In general, my model has a monetary steady state in which only a proportion of the agents hold money. Agents who do not hold money cannot participate in trade in the decentralized market. The proportion of agents holding money is endogenous and depends (negatively) on the level of expected inflation. As in Lagos and Wright's model, in equilibrium there is a positive welfare cost of expected inflation, but the origins of this cost are very different.     

On the dynamics of international inflation

We investigate the dynamic properties of inflation in 20 OECD countries with a novel approach based on the autocorrelation function. We find evidence in favor of long memory and nonlinearity. Linear autoregressive models are shown to be misspecified.     

Status Preference, Wealth and Dynamics in the Open Economy

Abstract. The implications of status preference in a simple open economy model are investigated in this paper. The open economy is modeled as a continuum of identical representative agents who have preferences over consumption and status. In the paper status is identified as relative wealth, which takes the form of relative holdings international financial assets. A symmetric macroeconomic equilibrium is derived in which status is the source of transitional dynamics for domestic consumption and the current account balance. This result illustrates another way to combine transitional dynamics with interior equilibria in the small open economy Ramsey model with perfect capital mobility. We also show that status preference plays a critical role in influencing the open economy's adjustment to government expenditure and world interest rate shocks.     

Trend shocks and the countercyclical U.S. current account

From 1960 to 2009, the U.S. current account balance has tended to decline during expansions and improve in recessions. We argue that shocks to the trend growth rate of productivity can help explain the countercyclical U.S. current account. Our framework is a two‐country, two‐good business cycle model in which international asset trade is limited to a single, non‐contingent bond. We identify trend and transitory shocks to U.S. productivity using generalized method of moments (GMM) estimation. The specification that best matches the data assigns a large role to trend shocks. The estimated model also captures key facts regarding international co‐movement.