The Passthrough of Labor Costs to Price Inflation

We use a time‐varying parameter/stochastic volatility VAR framework to assess how the passthrough of labor costs to price inflation has evolved over time in U.S. data. We find little evidence that independent movements in labor costs have had a material effect on price inflation in recent years, even for compensation measures where some degree of passthrough to prices still appears to be present. Our results cast doubt on explanations of recent inflation behavior that appeal to such mechanisms as downward nominal wage rigidity or a differential contribution of long‐term and short‐term unemployed workers to wage and price pressures.     

Price Stability in Economies with Habit Persistence

This paper shows that the divine‐coincidence does not hold in a sticky price model with external habit if a time‐varying tax rate on labor income is not implemented to fully eliminate the time‐varying distortions associated with external habit and monopoly power in goods market. The required labor income tax rate is inversely related to the risk‐free real interest rate and the markup in the goods market, but it is proportional to the degree of external habit. Under this circumstance, the optimal monetary policy commands a countercyclical interest rate, having a perfect negative correlation with tax rate in the sticky price model with external habit. If a time‐invariant tax is the only fiscal instrument, then the degree of external habit entails a gap between the private marginal rate of substitution between consumption and labor and the social marginal rate of substitution, generating an endogenous trade‐off between the stabilization of welfare‐relevant output gap and inflation. Under this circumstance, price stability is not the optimal policy. The monetary policy authority should optimally try to undo the time‐varying distortions associated with external habit and monopoly power in goods market by deviating from price stability.     

Reconsidering the Relationship between Inflation and Relative Price Variability

It has long been popularly believed that the relationship between inflation and relative price variability (RPV) is positive and stable. Using disaggregated CPI data for the United States and Japan, however, this study finds that the relationship is neither linear nor stable over time. The overall relationship is approximately U‐shaped around a nonzero threshold inflation rate. RPV therefore changes not with the inflation rate per se, but with the deviation of inflation from the threshold inflation rate. More importantly, the relationship is by no means stable over time but instead varies significantly in a way that coincides with regime changes of inflation or monetary policy. The relationship was positive during the period of high inflation of the 1970s and the early 1980s, as has been documented by a number of previous studies, whereas it takes a U‐shape profile during the Great Moderation. The results are robust to the use of core inflation, which excludes the traditionally volatile prices of food and energy. This paper then presents a modified version of the Calvo‐type sticky price model to describe the observed empirical regularities. Simulation experiments show that the modified Calvo model fits the data well, and that the underlying relationship hinges upon the degree of price rigidity, which is systematically related to inflation regime. For countries and periods with low inflation rates, the relationship takes a U‐shape as price adjustment is more sticky. In a high‐inflation environment, when price setting becomes more flexible, the U‐shaped profile vanishes.     

Technology,Utilization, and Inflation: What Drives the New Keynesian Phillips Curve?

We argue that the New Keynesian Phillips Curve literature has failed to deliver a convincing measure of real marginal costs. We start from a careful modeling of optimal price setting allowing for nonunitary factor substitution, nonneutral technical change, and time‐varying factor utilization rates. This ensures the resulting real marginal cost measures match volatility reductions and level changes witnessed in many U.S. time series. The cost measure comprises conventional countercyclical cost elements plus procyclical (and covarying) utilization rates. Although procyclical elements seem to dominate, the components of real marginal cost components are becoming less cyclical over time. Incorporating this richer driving variable produces more plausible price‐stickiness estimates than otherwise and suggests a more balanced weight of backward‐ and forward‐looking inflation expectations than commonly found. Our results challenge existing views of inflation determinants and have important implications for modeling inflation in New Keynesian models.     

Monetary Policy in a Low‐Inflation Environment: Developing a State‐Contingent Price‐Level Target

A number of academic studies find that either price‐level targeting or temporary above‐average inflation are nearly optimal policies to address a liquidity trap crisis. Still, central bankers and the public generally question whether even a temporarily higher inflation rate could be beneficial in addressing a liquidity trap or could be consistent with price stability over the longer term. At the same time, however, the Federal Reserve's projections for high unemployment and low inflation do not seem to be consistent with the best monetary policies to address the Fed's dual mandate responsibilities. Accordingly, it is useful to seriously discuss these potentially beneficial alternative policies.     

Credit Indicators as Predictors of Economic Activity: A Real‐Time VAR Analysis

Using readily available indicators of the profitability, price, and availability of credit—the term spread, junk‐bond spread, and banks’ “willingness to lend” as reported by the Federal Reserve—we show that it is possible to significantly improve on the real‐time output and employment predictions of forecasting professionals at the medium‐run horizons that are most relevant to policymakers and private decision makers. Key to this improvement is a flexible state–space model of data revisions. The willingness‐to‐lend variable is the best real‐time predictor of GDP growth. For forecasting job growth, all three credit indicators prove helpful.     

Durable Goods,Investment Shocks,and the Comovement Problem

Sticky‐price models suggest that capital investment shocks are an important driver of business cycle fluctuations. Despite quantitative importance in explaining business cycles, a comovement problem emerges because the shocks generate intertemporal substitution effects away from consumption toward investment. This paper resolves the problem by extending the standard sticky‐price model to a two‐sector model with consumer durable services. When durable goods are used as investment in capital and consumer durables, positive capital investment shocks also generate intratemporal substitution effects away from consumer durable services toward nondurable consumption that dominates intertemporal effects. Consequently, consumption increases, and the comovement problem is resolved.     

Monetary Policy Response to Oil Price Shocks

How should monetary authorities react to an oil price shock? This paper shows that in a noncompetitive economy, policies that perfectly stabilize prices entail large welfare costs, hence explaining the reluctance of policymakers to enforce them. The policy trade‐off is nontrivial because oil (energy) is an input to both production and consumption. As welfare‐maximizing policies are hard to implement and communicate, I derive a simple interest rate rule that depends only on observables but mimics the optimal plan in all dimensions. The optimal rule is hard on core inflation but accommodates oil price changes.     

Aggregate Implications of Heterogeneous Households in a Sticky‐Price Model

This paper analyzes the role of heterogeneous households in propagating shocks over the business cycle by generalizing a basic sticky‐price model to allow for imperfect risk sharing between households that differ in labor incomes. I show that imperfectly insured household consumption distorts household incentive to supply labor hours through an idiosyncratic income effect, which in turn generates strategic complementarities in price setting and thus amplifies business cycle fluctuations. This mechanism diminishes the role of nominal rigidities and makes sticky‐price models more consistent with microeconomic evidence on the frequency of price changes.     

Imperfectly Credible Disinflation under Endogenous Time‐Dependent Pricing

The real effects of an imperfectly credible disinflation depend critically on the extent of price rigidity. We examine this interaction in a model with endogenous time‐dependent pricing. Both the endogenous initial degree of price rigidity and changes in the duration of price spells during disinflation are important in explaining the effects of imperfect credibility. We initially consider a setup where the degree of credibility is fixed and then allow agents to update beliefs about the “type” of monetary authority that they face. In both cases, the interaction between endogeneity of pricing behavior and imperfect credibility increases the output costs of disinflation.     

A Tale of Two Rigidities: Sticky Prices in a Sticky‐Information Environment

Macroeconomic models with microeconomic foundations allow for comparisons with macro and micro empirical evidence. This paper proposes a model wherein firms: (i) acquire information infrequently, generating sticky information ( Mankiw and Reis 2002 ) and (ii) face menu costs, producing state‐dependent sticky prices. I estimate parameters via indirect inference and show that under considerable real rigidity, sticky prices in a sticky‐information environment are consistent with micro and macro evidence. Sticky prices not only help match micro data on price changes’ size and durations between adjustments; they also improve the model's fit with the macro data, as embodied in an empirical Phillips curve.     

Microdata Evidence on the Empirical Importance of Selection Effects in Menu‐Cost Models

We use microdata on product prices linked to information on the producing firms that set them to study to what extent the timing of price changes reacts to changes in marginal cost. This self‐selection of price changes is a key feature in the canonical Menu‐Cost model a la Golosov and Lucas Jr. (2007), which may generate near monetary neutrality (Golosov and Lucas Jr. 2007, Karadi and Reiff 2016), but is absent in the Calvo (1983) model. We find that the microdata strongly favors the Calvo (1983) model. Thus, upstream in the supply chain, price setting is best characterized by a very low degree of self‐selection into price changes.     

The Role of Oil Price Shocks in Causing U.S. Recessions

Although oil price shocks have long been viewed as one of the leading candidates for explaining U.S. recessions, surprisingly little is known about the extent to which oil price shocks explain recessions. We provide a formal analysis of this question with special attention to the possible role of net oil price increases in amplifying the transmission of oil price shocks. We quantify the conditional effect of oil price shocks in the net oil price increase model for all episodes of net oil price increases since the mid‐1970s, analyze its determinants, and show that the linear model fits the data better.     

On the Asymmetric U‐Shaped Relationship between Inflation,Inflation Uncertainty,and Relative Price Skewness in the UK

We investigate the asymmetric relationships between aggregate inflation and the second and third moments of the cross‐sectional distribution of relative prices using a modified Calvo pricing model with regime‐dependent price rigidities. Calibration experiments reveal that the inflation‐standard deviation and inflation‐skewness relationships exhibit U‐shaped asymmetries around the historical mean inflation rate. UK sectoral data support our results. We conclude that monetary policy should target an inflation rate proximate to the (common) minima of these nonlinear relationships and that core inflation measures should not be used for policy purposes as they exclude much of the information contained in the higher moments.     

Sectoral Comovement,Monetary Policy Shocks,and Input–Output Structure

The comovement of output across the sector producing nondurables (i.e., nondurable goods and services) and the sector producing durables is well established in the monetary business cycle literature. However, standard sticky‐price models that incorporate sectoral heterogeneity in price stickiness (i.e., sticky nondurables prices and flexible durables prices) cannot generate this feature. We argue that an input–output (I–O) structure provides a solution to this problem. Here, we develop a two‐sector model with an I–O structure, which is calibrated to the U.S. economy. In the model, each sector’s output affects those of the others by acting as an intermediate input. This connection between the sectors provides a channel through which sectoral comovement is induced.     

Long‐Run Inflation and the Distorting Effects of Sticky Wages and Technical Change

We show that the Calvo price‐setting model is not necessarily inconsistent with evidence of a weak relation between positive trend inflation and price dispersion. We identify the interaction between sticky wages and technical change as factors disrupting the allocative role of the wage system under positive trend inflation. In turn, this interaction generates inefficient wage dispersion, as opposed to price dispersion, which fuels inflation costs. We conclude that it is too early to dismiss the New Keynesian model as a useful vehicle to assess the costs of inflation.     

Nowcasting U.S. Headline and Core Inflation

Forecasting future inflation and nowcasting contemporaneous inflation are difficult. We propose a new and parsimonious model for nowcasting headline and core inflation in the U.S. consumer price index and price index for personal consumption expenditures that relies on relatively few variables. The model's nowcasting accuracy improves as information accumulates over a month or quarter, outperforming statistical benchmarks. In real‐time comparisons, the model's headline inflation nowcasts substantially outperform those from the Blue Chip consensus and the Survey of Professional Forecasters. Across all four inflation measures, the model's nowcasting accuracy is comparable to that of the Federal Reserve Board's Greenbook.     

Markups and the Welfare Cost of Business Cycles: A Reappraisal

Gali, Gertler, and Lopez‐Salido (2007) recently show quantitatively that fluctuations in the efficiency of resource allocation do not generate sizable welfare costs. In their economy, which is distorted by monopolistic competition in the steady state, we show that they underestimate the welfare cost of these fluctuations by ignoring the negative effect of aggregate volatility on average consumption and leisure. As monopolistic suppliers, both firms and workers aim to preserve their expected markups; the interaction between aggregate fluctuations and price‐setting behavior results in average consumption and employment levels that are lower than their counterparts in the flexible‐price economy. This level effect increases the efficiency cost of business cycles. It is all the more sizable with the degree of inefficiency in the steady state, lower labor–supply elasticities, and when prices instead of wages are rigid.     

The Dynamics of Gasoline Prices: Evidence from Daily French Micro Data

Using millions of individual gasoline prices collected at a daily frequency, we examine the speed at which market prices of refined oil are transmitted to retail gasoline prices in France. For that, we estimate a reduced‐form model of state‐dependent pricing where thresholds triggering price changes are allowed to vary over time and depend on the duration since the last price change. We find that the degree of pass‐through of wholesale prices to retail gasoline prices is on average 0.77 for diesel and 0.67 for petrol and depend on local market characteristics. The duration for a shock to be fully transmitted into prices is about 10 days. There is no significant asymmetry in the transmission of wholesale price to retail prices. Finally, the duration since the last price change has a significant effect on thresholds triggering price changes but a large variance of idiosyncratic shocks on thresholds is also crucial to replicate the size distribution of price changes.     

Why Don’t Oil Shocks Cause Inflation? Evidence from Disaggregate Inflation Data

This paper uses disaggregate U.S. inflation data to evaluate explanations for the breakdown of the relationship between oil price shocks and consumer price inflation. A data set with measures of inflation, energy intensity, labor intensity, and sensitivity to monetary policy is constructed for 97 sectors that make up core CPI inflation. A comparison of the 1973–85 and 1986–2006 time periods reveals that substitution away from energy use in production and monetary policy were both important, with approximately two‐thirds of the change in response of inflation to oil shocks being due to reduced energy usage, and one‐third to monetary policy. We find no evidence that other factors, such as changes in wage rigidities or changes in the persistence of oil shocks, played a role.