Money,inflation, and output growth: Does the aggregate demand-aggregate supply model explain the international evidence?

Money, Inflation, and Output Growth: Does the Aggregate Demand-Aggregate Supply Model Explain the International Evidence? - Using annual post-war data for 32 countries, it is shown that output and the price level are positively related along the aggregate supply and negatively related along the aggregate demand curve. This implies that the negative correlation between inflation and growth simply means that the price level has been countercyclical as aggregate supply shocks domi-nated aggregate demand shocks. It is also shown that money growth has positive and permanent effects on inflation, but may affect output only in the short run: in the long run, money is probably neutral.     

On the choice of an anchor for the GCC currency: does the symmetry of shocks extend to both the oil and the non-oil sectors?

This paper assesses the costs of forming a monetary union among the Gulf Cooperation Council (GCC) countries by looking at economic linkages within the GCC, and between the GCC and the potential anchors (the US, and major European countries such as France, Germany and Italy) for their proposed new currency. We investigate the importance of the US dollar compared to the Euro by focusing on aggregate demand (AD) and aggregate supply (AS) shock symmetry across these countries. We differentiated between oil and non-oil sector by estimating structural vector autoregression (SVAR) models with a combination of variables: oil output, non-oil output, total output, nominal/real price of oil and overall price level. One set of models was identified with the long-run restrictions of Blanchard and Quah (Am Econ Rev 79(4):655–673, 1989), whereas the set that assesses the robustness of the findings was estimated with the short-run restrictions of Sims (Eur Econ Rev 36(5):975–1000, 1992). We find overwhelming support for AD shock symmetry across the GCC countries and between the GCC and the US, but none for the major European countries with the GCC. Non-oil AS shocks are mostly asymmetric, but oil AS shocks are mostly symmetric when the real price of oil is included. This agrees with the view that GCC countries are subjected to common oil shocks. It also suggests that previous VAR models estimated to pass judgment on the feasibility of monetary union across GCC countries may have suffered from problems of mis-specification if the real price of oil was not considered. We surmise that the US dollar is a better anchor candidate for anchoring the new GCC currency than the Euro, since US monetary policy can at least help smooth demand shocks in these countries.     

The dynamics of aggregate demand and supply shocks in ASEAN countries

This paper revisits the issue of identification of aggregate demand and supply shocks in ASEAN countries using an alternative identification scheme where the aggregate demand and supply shocks are allowed to be correlated. Applying the technique of Cover, Enders, and Hueng (2006) within a bivariate Structural VAR model, this paper shows that aggregate demand and supply shocks are interrelated (positively) in ASEAN countries. Unlike most of the previous studies, it is found that changes in the output level are mainly driven by aggregate demand shocks, whereas supply shocks play the dominant role in affecting inflation in ASEAN countries. The correlation of the shocks across the countries is found to be quite small, suggesting that ASEAN is still not set to form a common currency union.     

Commodity Prices, Inflationary Pressures, and Monetary Policy: Evidence from BRICS Economies

We assess the transmission of monetary policy and the impact of fluctuations in commodity prices on the real economy for the five biggest and fastest growing emerging market economies: Brazil, Russia, India, China and South Africa (BRICS). Using modern econometric techniques, we show that a monetary policy contraction has a negative effect on output, suggesting that it can lean against unexpected macroeconomic shocks even when the financial markets are not well-developed in this group of countries. We also uncover the importance of commodity price shocks, which lead to a rise in inflation and demand an aggressive behaviour from central banks towards inflation stabilisation.     

Exchange Rate Variability and the Macro-economy: Evidence from Developing and Developed Countries

Abstract

Using annual data, the paper studies the time-series evidence regarding the allocation of fluctuations in the exchange rate between demand components, real growth, and price inflation in a sample of developing and advanced countries. The evidence reveals patterns of interaction between the macro-economy and exchange rate variability. Across developing countries, appreciation decreases the cost of imports and price inflation, while depreciation shrinks the output supply, indicating high dependency on imported goods. The reduction in output supply correlates with higher inflation and an increase in the import value. In contrast, the evidence of the negative effect of currency appreciation on output growth is more prevalent across advanced countries, while depreciation stimulates competitiveness, resulting in higher demand for exports, investment and consumption. Across developing countries, exchange rate variability decreases trend real growth and increases trend price inflation. Across advanced countries, exchange rate variability decreases trend real growth while increasing the variability of price inflation and import growth. Minimizing variability of the exchange rate would be beneficial to sustain higher growth and reduce cyclical variability in developing and advanced countries.     

The dynamic effects of shocks to labour markets: evidence from OECD countries

This paper uses a set of plausible long-run identifying restrictionson a three-variable system, including output growth, real wagegrowth, and the unemployment rate, to isolate three independentstructural shocks which drive fluctuations in those variablesin a sample of 16 OECD countries during 1950-96. These shocksare interpreted as aggregate demand, productivity, and laboursupply disturbances. As a by-product of the previous analysis,the cyclical behaviour of real wages in response to a demandshock is re-examined and two indices of real wage rigidity arederived.     

Asymmetric wage indexation

Models of wage indexation uniformly have been based on the simplifying assumption that nominal wages adjust upward or downwrd symmetrically with unexpected price increases or decreases. Indexation typically is asymmetric in actual contracts, however. Wages are indexed to price increases but not to price reductions. This paper analyzes a macroeconomic model with asymmetric indexation. On the one hand, this paper finds that when stable equilibria supporting use of such asymmetrically indexed contracts exist, the result is an unambiguous downward bias in the base contract wage, because workers must pay a premium for insurance against real wage reductions that unexpected inflation otherwise would induce. On the other hand, the paper concludes that the likelihood of existence of stable equilibria supporting positive wage indexation generally declines as aggregate demand variability rises relative to the variability of aggregate supply. This may help explain why relatively low levels of wage indexation actually are observed in nations with relatively contained aggregate demand volatility.     

Has Greater Competition Restrained U.S. Inflation?

This paper shows how increased goods market competition affects the behavior of inflation in a multisector economy. By raising the price elasticity of demand, increased goods market competition theoretically lowers inflation and makes the aggregate price level less sensitive to aggregate demand shocks. We find that proxies for the aggregate degree of goods market competition are statistically and economically significant in short-run Phillips curve models of core inflation. Evidence indicates that heightened goods market competition has flattened the slope of the short-run, expectations-augmented Phillips curve and slightly lowered the nonaccelerating inflation rate of unemployment (NAIRU).     

New Keynesian Explanations of Cyclical Movements in Aggregate Inflation and Regional Inflation Differentials

What determines the cyclical behavior of aggregate inflation and regional inflation differentials? The answer has strong implications for monetary policy and in Europe for the Stability and Growth Pact. In the United States, inflation rates move pro-cyclically, and across the Euro Area, inflation differentials are positively correlated with growth differentials. This suggests that demand shocks are the primary determinants of the cyclical behavior of aggregate inflation and regional inflation differentials. In this paper, we discuss New Keynesian explanations of these correlations, and we argue that demand shocks are either missing or inadequately modeled in the in typical New Keynesian model.     

Global food prices and monetary policy in an emerging market economy: The case of India

This paper investigates a perception in the political debates as to what extent poor countries are affected by price movements in the global commodity markets. To test this perception, we use the case of India to establish in a standard SVAR model that global food prices influence aggregate prices and food prices in India. To further analyze these empirical results, we specify a small open economy New-Keynesian model including oil and food prices and estimate it using observed data over the period 1996Q2 to 2013Q2 by applying Bayesian estimation techniques. The results suggest that a big part of the variation in inflation in India is due to cost-push shocks and, mainly during the years 2008 and 2010, also to global food price shocks, after having controlled for exogenous rainfall shocks. We conclude that the inflationary supply shocks (cost-push, oil price, domestic food price and global food price shocks) are important contributors to inflation in India. Since the monetary authority responds to these supply shocks with a higher interest rate which tends to slow growth, this raises concerns about how such output losses can be prevented by reducing exposure to commodity price shocks.     

Permanent and Temporary Components of Stock Prices: Evidence from Assessing Macroeconomic Shocks

This paper outlines a simple macro model with overlapping wage contracts to investigate how the temporary and permanent components of stock price movements may be related to aggregate macro-economic supply and demand disturbances. In the content of the model, we show that aggregate demand shocks have only temporary effects on real stock prices, while supply shocks may affect the level of real stock prices permanently. Moreover, the temporary component in U.S. stock prices, identified by placing appropriate structural restrictions on a vector autoregressive system estimated for the postwar period, is statistically significant. This evidence supports the mean-reversion hypothesis that stock prices are not pure random walks. The finding is robust to the choice of variables used in the vector autoregressive system and periodicity.     

Inflation in South Africa: An Assessment of Alternative Inflation Models

We consider the relative empirical performance of a range of inflation models for South Africa. Model coverage is of Phillips curve, New Keynesian Phillips curve, monetarist and structural models of inflation. Our core findings are that the single most robust covariate of inflation is unit labour cost. We further decompose unit labour cost into changes in the nominal wage and real labour productivity. The principal association is a strong positive relationship between inflation and nominal wages, while improvements in real labour productivity report only a relatively weak negative association with inflation. Supply‐side shocks also consistently report an association with inflation. As to demand‐side shocks, the output gap does not return a robust statistical association with inflation. Instead, it is growth in the money supply and government expenditure which return robust and theoretically consistent associations with inflationary pressure.     

Growth,employment and income distribution in Egyptian agriculture, 1964–1979

This paper is a study of the aggregate behavior of crop production in Egypt. We find that the output growth rate declined in the 1970s but there were some signs of recovery towards the end of the decade. This trend cannot be explained by the observed-cyclical movements in profitability and in the real price of aggregate output. On the other hand, investment in infrastructure goes a long way towards explaining the trends both in aggregate output and in land profitability. Increased investment in agriculture infrastructure tends to raise the growth rate of the sector and, at the same time, to increase labor's share in production at the cost of property share. Our observations also suggest that the demand for agricultural labor is rather inelastic with respect to the wage rate. Therefore, using the agricultural sector as an absorbent of employment shocks in the rest of the economy may lead to significant variability in income distribution.     

Sources of Real Exchange Rate Volatility in Africa: The Case of ECOWAS*

Abstract: This study examines the impact of (real) demand shocks, (aggregate) supply shocks, and monetary shocks on real exchange rates in 13 West African countries. We observe that the real demand shocks explain most of the fluctuations in real exchange rates in all these countries. Accordingly, policymakers should adopt a careful demand management strategy by controlling government expenditure and taxes.     

A nonlinear ARDL model of inflation dynamics in the Philippine economy

This study investigated whether global oil price changes, exchange rate, interest rate, and economic output exert symmetric or asymmetric pass-through effects on inflation in the Philippines. A Nonlinear Autoregressive Distributed Lag (NARDL) model was fitted to the observable data using quarterly observations from 1998 to 2019. Knowledge of these relationships is important in monetary policy setting in achieving targeted inflation; the Philippines adopted inflation targeting in 2002. The finding shows that world oil price shocks are still prominent and the most important determinants of inflation variations in the country. There is prima facie evidence on the short-run asymmetry of oil price changes to inflation. Exchange rate pass-through to inflation was very minimal in the short-run, and there is no long-run effect. Evidence that interest rate and demand shocks have a long-run asymmetric effect on inflation was found. These findings imply that monetary policy setting should account for the asymmetric effects of inflation determinants. Study results provide a deeper understanding of how positive and negative changes of inflation determinants affect actual inflation, which aids policymakers in achieving targeted inflation.     

Deflation,Productivity Shocks and Gold: Evidence from the 1880–1914 Period

In this paper we examine the sources and impact of deflation on the growth experiences of the four dominant countries on the gold standard in the period 1880–1913: the United States, The United Kingdom, France and Germany. We distinguish between good deflation, (driven by positive aggregate supply shocks) and bad deflation (driven by aggregate demand shocks). We use an empirical Blanchard/Quah model which decomposes the behaviour of prices, output and the money stock into the impact of shocks such as a world price level shock, a domestic supply shock, and domestic demand shocks including a shock to the domestic gold stock. Our key finding is that the European economies were essentially classic in the sense that output was mainly supply driven and that money was neutral even when country specific gold stocks are included. In the United States, however, we observe both good and bad deflation.     

What to Aim for? The Choice of an Inflation Objective when Openness Matters

Inflation targeting countries generally define the inflation objective in terms of the consumer price index. Studies in the academic literature, however, reach conflicting conclusions concerning which measure of inflation a central bank should target in a small open economy. This paper examines the properties of domestic, CPI, and real-exchange-rate-adjusted (REX) inflation targeting. In one class of open economy New Keynesian models there is an isomorphism between optimal policy in an open versus closed economy. In the type of model we consider, where the real exchange rate appears in the Phillips curve, this isomorphism breaks down; openness matters. REX inflation targeting restores the isomorphism but this may not be desirable. Instead, under domestic and CPI inflation targeting the exchange rate channel can be exploited to enhance the effects of monetary policy. Our results indicate that CPI inflation targeting delivers price stability across the three inflation objectives and will be desirable to a central bank with a high aversion to inflation instability. CPI inflation targeting also does a better job of stabilizing the real exchange rate and interest rate which is an advantage from the standpoint of financial stability. REX inflation targeting does well in achieving output stability and has an advantage if demand shocks are predominant. In general, the choice of the inflation objective affects the trade-offs between policy goals and thus policy choices and outcomes.     

Does China have Inflationary Effects on the USA and Japan？

With China＇s share in global trade increasing rapidly, some argued in 2002-2003 that China was exporting deflation to other countries as it was dumping cheap goods in mature markets. Later, others argued that China was causing sharp increases in global prices. This paper uses several econometric techniques to assess the extent of the link between inflation rates between China and the USA and Japan. Only limited empirical evidence at the aggregate level is found for consumer price inflation in China leading to price changes in the USA and Japan. However, there is some evidence that inflation in the USA has an impact on Chinese inflation. The results seem consistent with the Federal Reserve and the Bank of Japan being concerned about inflation and, hence, adjusting policy such that inflation shocks have no significant effect on overall inflation. Recent Chinese price rises are unlikely to have a material effect on the USA or Japan.     

On the Sources of Inflation in Kenya: A Model‐Based Approach

We develop a semi‐structural new‐Keynesian open‐economy model – with separate food and non‐food inflation dynamics to study the sources of inflation in Kenya in recent years. To do so, we filter international and Kenyan data (on output, inflation and its components, exchange rates and interest rates) through the model to recover a model‐based decomposition of most variables into trends (or potential values) and temporary movements (or gaps) – including for the international and domestic relative price of food. We use the filtration exercise to recover the sequence of domestic and foreign macroeconomic shocks that account for business cycle dynamics in Kenya over the last few years, with a special emphasis on the various factors (international food prices, monetary policy) driving inflation. We find that while imported food price shocks have been an important source of inflation, both in 2008 and more recently, accommodating monetary policy has also played a role, most notably through its effect on the nominal exchange rate. We also discuss the implications of this exercise for the use of model‐based monetary policy analysis in sub‐Saharan African countries.     

Fiscal Shocks and The Sectoral Composition of Output

We study the impact of shocks to different types of government spending on the sectoral composition of output for a panel of EMU member countries. We find that fiscal shocks lead to an increase in the relative size of the nontraded sector, with the impact varying across the different spending categories. There is typically no significant impact on the level of production in the tradables sector but the level of imports increases and the level of exports declines in most cases. Overall, the results show that fiscal shocks matter not only for aggregate variables but also for the sectoral composition of output. The sectoral output results are consistent with previous work concerning the impact of fiscal shocks on the real exchange rate and the relative price of nontradables.