Inflation Expectations, Adverse Aggregate Supply Shock and Long-Term Inflation Expectations

Asymmetric impact of oil price shocks on inflation: Evidence from quantile-on-quantile regression

The policy goal of merger remedies is to facilitate mergers’ potential contribution to dynamic and productive efficiencies while preserving pre-merger consumer surplus. But recent empirical scholarship shows that most remedies fail to achieve this goal. I propose an incentive contract, inspired by the theory of incentive-based regulation in general and price-cap regulation in particular, that can serve as a conduct remedy and that has strong theoretical and practical advantages relative to standard divestiture and conduct remedies. The remedy requires the merged firm to contract with a private third party to whom it makes cash payments whenever it raises price or lowers quantity or quality relative to pre-merger levels, where the payments are at least as large as the revenue gain from such actions. To cope with adverse demand shocks, the contract lets the firm sell a lower than pre-merger quantity so long as price is no higher and quality no lower than pre-merger. To cope with adverse supply shocks, the pre-merger price threshold that the contract does not allow the firm’s post-merger price to exceed can be adjusted by an index of input cost inflation. To cope with variations in product quality, the contract lets the firm vary quality so long as the post-merger product is weakly revealed-preferred by its customers to the pre-merger product. The payout structure effectively imposes a contractual obligation on the firm to preserve pre-merger consumer surplus, while giving the firm a residual claim on all merger-induced cost savings thereby eliminating moral hazard.The firm’s payouts to its contractual counterparty are contingent on the same three variables — price, quantity, and quality — that are the central terms in the firm’s own sales contracts with its customers. The same market forces, contract laws, and external auditing mechanisms that ensure adequate observability of these variables to the firm’s customers therefore ensure their observability to the counterparty. The contract does not require information on economic costs or the demand curve. In contrast to divestitures, my remedy does not require the merging firm to shed parts potentially critical to its efficiency.Standard conduct remedies suffer from risks of asymmetric information, incomplete specification, countervailing incentives, irrelevance in face of market dynamics, and agency inappropriateness for regulatory roles. In contrast, my contract conditions on variables less vulnerable to problems of asymmetric information and incomplete specification. It shapes incentives only to the minimal extent necessary to preserve consumer surplus, only as much as any other contract does, and in a way that induces the firm to find the least cost way of preserving consumer surplus. It addresses market dynamics arising from adverse demand and supply shocks and product innovation. It absolves the agencies of the fraught responsibilities of predicting merger effects and post-merger regulation. It relies on contract- and market-based mechanisms for securing the policy goals of the merger regime. It is more sensitive, specific, and implementable than standard remedies. It is potentially the most light-handed of remedies since a merged firm committed to fulfilling its part of the policy bargain will find none of its constraints binding.

Macroeconomic summary Annual inflation continued to rise in the first quarter (8.5%) and again outpaced both market expectations and the technical staff’s projections. Inflation in major consumer price index (CPI) baskets has accelerated year-to-date, rising in March at an annual rate above 3%. Food prices (25.4%) continued to contribute most to rising inflation, mainly affected by a deterioration in external supply and rising costs of agricultural inputs. Increases in transportation prices and in some utility rates (energy and gas) can explain the acceleration in regulated items prices (8.3%). For its part, the increase in inflation excluding food and regulated items (4.5%) would be the result of shocks in supply and external costs that have been more persistent than expected, the effects of indexation, accumulated inflationary pressures from the exchange rate, and a faster-than-anticipated tightening of excess productive capacity. Within the basket excluding food and regulated items, external inflationary pressures have meaningfully impacted on goods prices (6.4%), which have been accelerating since the last quarter of 2021. Annual growth in services prices (3.8%) above the target rate is due primarily to food away from home (14.1%), which was affected by significant increases in food and utilities prices and by a rise in the legal monthly minimum wage. Housing rentals and other services prices also increased, though at rates below 3%. Forecast and expected inflation have increased and remain above the target rate, partly due to external pressures (prices and costs) that have been more persistent than projected in the January report (Graphs 1.1 and 1.2). Russia’s invasion of Ukraine accentuated inflationary pressures, particularly on international prices for certain agricultural goods and inputs, energy, and oil. The current inflation projection assumes international food prices will increase through the middle of this year, then remain high and relatively stable for the remainder of 2022. Recovery in the perishable food supply is forecast to be less dynamic than previously anticipated due to high agricultural input prices. Oil prices should begin to recede starting in the second half of the year, but from higher levels than those presented in the previous report. Given the above, higher forecast inflation could accentuate indexation effects and increase inflation expectations. The reversion of a rebate on value-added tax (VAT) applied to cleaning and hygiene products, alongside the end of Colombia’s COVID-19 health emergency, could increase the prices of those goods. The elimination of excess productive capacity on the forecast horizon, with an output gap close to zero and somewhat higher than projected in January, is another factor to consider. As a consequence, annual inflation is expected to remain at high levels through June. Inflation should then decline, though at a slower pace than projected in the previous report. The adjustment process of the monetary policy rate wouldcontribute to pushing inflation and its expectations toward the target on the forecast horizon. Year-end inflation for 2022 is expected to be around 7.1%, declining to 4.8% in 2023. Economic activity again outperformed expectations. The technical staff’s growth forecast for 2022 has been revised upward from 4.3% to 5% (Graph 1.3). Output increased more than expected in annual terms in the fourth quarter of 2021 (10.7%), driven by domestic demand that came primarily because of private consumption above pre-pandemic levels. Investment also registered a significant recovery without returning to 2019 levels and with mixed performance by component. The trade deficit increased, with significant growth in imports similar to that for exports. The economic tracking indicator (ISE) for January and February suggested that firstquarter output would be higher than previously expected and that the positive demand shock observed at the end of 2021 could be fading slower than anticipated. Imports in consumer goods, retail sales figures, real restaurant and hotel income, and credit card purchases suggest that household spending continues to be dynamic, with levels similar to those registered at the end of 2021. Project launch and housing starts figures and capital goods import data suggest that investment also continues to recover but would remain below pre-pandemic levels. Consumption growth is expected to decelerate over the year from high levels reached over the last two quarters. This would come amid tighter domestic and external financial conditions, the exhaustion of suppressed demand, and a deterioration of available household income due to increased inflation. Investment is expected to continue to recover, while the trade deficit should tighten alongside high oil and other export commodity prices. Given all of the above, first-quarter economic growth is now expected to be 7.2% (previously 5.2%) and 5.0% for 2022 as a whole (previously 4.3%). Output growth would continue to moderate in 2023 (2.9%, previously 3.1%), converging similar to long-term rates. The technical staff’s revised projections suggest that the output gap would remain at levels close to zero on the forecast horizon but be tighter than forecast in January (Graph 1.4). These estimates continue to be affected by significant uncertainty associated with geopolitical tensions, external financial conditions, Colombia’s electoral cycle, and the COVID-19 pandemic. External demand is now projected to grow at a slower pace than previously expected amid increased global inflationary pressures, high oil prices, and tighter international financial conditions than forecast in January. The Russian invasion of Ukraine and its inflationary effects on prices for oil and certain agricultural goods and inputs accentuated existing global inflationary pressures originating in supply restrictions and increased international costs. A decline in the supply of Russian oil, low inventory levels, and continued production limits on behalf of the Organization of Petroleum Exporting Countries and its allies (OPEC+) can explain increased projected oil prices for 2022 (USD 100.8/barrel, previously USD 75.3) and 2023 (USD 86.8/barrel, previously USD 71.2). The forecast trajectory for the U.S. Federal Reserve (Fed) interest rate has increased for this and next year to reflect higher real and expected inflation and positive performance in the labormarket and economic activity. The normalization of monetary policy in various developed and emerging market economies, more persistent supply and cost shocks, and outbreaks of COVID-19 in some Asian countries contributed to a reduction in the average growth outlook for Colombia’s trade partners for 2022 (2.8%, previously 3.3%) and 2023 (2.4%, previously 2.6%). In this context, the projected path for Colombia’s risk premium increased, partly due to increased geopolitical global tensions, less expansionary monetary policy in the United States, an increase in perceived risk for emerging markets, and domestic factors such as accumulated macroeconomic imbalances and political uncertainty. Given all the above, external financial conditions are tighter than projected in January report. External forecasts and their impact on Colombia’s macroeconomic scenario continue to be affected by considerable uncertainty, given the unpredictability of both the conflict between Russia and Ukraine and the pandemic. The current macroeconomic scenario, characterized by high real inflation levels, forecast and expected inflation above 3%, and an output gap close to zero, suggests an increased risk of inflation expectations becoming unanchored. This scenario offers very limited space for expansionary monetary policy. Domestic demand has been more dynamic than projected in the January report and excess productive capacity would have tightened more quickly than anticipated. Headline and core inflation rose above expectations, reflecting more persistent and important external shocks on supply and costs. The Russian invasion of Ukraine accentuated supply restrictions and pressures on international costs. This partly explains the increase in the inflation forecast trajectory to levels above the target in the next two years. Inflation expectations increased again and are above 3%. All of this increased the risk of inflation expectations becoming unanchored and could generate indexation effects that move inflation still further from the target rate. This macroeconomic context also implies reduced space for expansionary monetary policy. 1.2 Monetary policy decision Banco de la República’s board of directors (BDBR) continues to adjust its monetary policy. In its meetings both in March and April of 2022, it decided by majority to increase the monetary policy rate by 100 basis points, bringing it to 6.0% (Graph 1.5).

This chapter explores the information content of long-term inflation expectations inferred from break-even inflation rates and the policy implications thereof. Evidence established that actual and counterfactual long-term inflation expectations are “poorly” anchored. Evidence reveals there is pass-through from positive long-term inflation expectation shock to headline CPI inflation. Long-term inflation expectations propagate the adverse inflation shocks into the real economy. Periods of heightened inflationary pressures result in elevated long-term inflation expectations. In policy terms, this suggests policy makers should adopt a policy stance that aims to break down such adverse reinforcing tendencies.

This paper addresses the identification of supply and demand shocks in the South African economy over the 1960–2020 period, the relative importance of the two types of shock to fluctuations of growth and inflation from their steady‐state values, as well as the potential impact of the two types of shocks on the steady‐state growth and inflation values. Crucially, the paper examines the significance of three alternative identification strategies on the nature of supply and demand shocks and their impact on the economy: zero shock covariance in the presence of long‐run demand neutrality; non‐zero shock covariance in the presence of long‐run demand neutrality and long‐run demand non‐neutrality with zero shock covariance. Interest lies in which of the identification strategies provides shock decompositions that are theoretically coherent and congruent with the empirics of South African growth and inflation. Results support non‐zero shock covariance in the presence of long‐run demand neutrality identification. The analysis suggests that growth shocks in South Africa are dominated by supply shocks, and inflation shocks by demand shocks. Further, negative supply shocks lower steady state growth and raise steady‐state inflation, while positive demand shocks only raise steady‐state inflation and are growth neutral. South Africa appears relatively isolated from international productivity shocks.

Do inflation expectations, external and uncertainty shocks shift the Taylor curve? Evidence shows that a positive Federal Funds Rate (FFR) shock leads to a delayed increase in the repo rate, a decline in the repo rate-FFR rate spread and the deterioration in the current account. Foreign economic policy uncertainty shocks result in the increase in the domestic Taylor curve and, in turn, the increased gross capital outflows magnify the Taylor curve responses to elevated economic policy uncertainty shocks. The inflation and output-gap volatilities increase following a positive inflation expectations shock. A positive inflation expectations shock when inflation expectations are above 6 per cent increases the Taylor curve. On the other, inflation expectations have absolutely no effect on the Taylor curve when inflation expectations are below 6 per cent. Elevated and unanchored inflation expectations induce a shift in the Taylor curve. However, evidence shows that inflation expectations below 4.5 per cent minimise the output-gap and inflation volatilities.

Crises in Economic Thought, Secular Stagnation, and Future Economic Research

SummaryWe use a structural vector autoregressive (SVAR) model to study the German natural gas market and investigate the impact of the 2022 Russian supply stop on the German economy. Combining conventional and narrative sign restrictions, we find that gas supply and demand shocks have large and persistent price effects, while output effects tend to be moderate. The 2022 natural gas price spike was driven by adverse supply shocks and positive storage demand shocks, as Germany filled its inventories before the winter. Counterfactual simulations of an embargo on natural gas imports from Russia indicate similar positive price and negative output effects compared with what we observe in the data.

Comment

Monetary Policy Report - October 2022

Bu çalışma, Türkiye’de 2003 Ocak-2019 Ocak dönemi arasında Ready (2018) tarafından önerilen üç farklı petrol fiyatı şokunun (talep, arz ve risk) BIST100 getirisi üzerindeki doğrusal olmayan etkisini NARDL modeli yaklaşımı ile incelemektedir. Elde ettiğimiz sonuçlarda petrol fiyatı şoklarıyla BIST100 getirisi arasında doğrusal olmayan eşbütünleşme ilişkisinin varlığına ve petrol fiyatı şoklarındaki pozitif ve negatif değişmelerin kısa ve uzun dönemde önemli ölçüde değiştiği sonucuna rastlanmıştır. Pozitif ve negatif petrol talep şokları katsayıları sırasıyla, pozitif ve negatiftir ve pozitif petrol talep şokunun negatif petrol talep şokundan daha büyük ekonomik etkiye sahiptir. Bu sonuç global talep artışından hisse getirilerinin daha fazla etkilendiği anlamına gelmektedir. Toplam etkiler değerlendirildiğinde hem pozitif petrol arz şokunun hem de pozitif petrol talep risk şokunun incelenen dönemde hisse senedi getirilerinin azalmasında daha büyük etkiye sahip olduğu sonucuna ulaşılmıştır.

• Discern the nature of the interaction between LTVs and the repo rate since 2001 • Assess the extent to which the tight (loose) LTVs reinforce (neutralize) the contractionary (accommodative) monetary policy stance • Analyze whether the transmission of the LTV shocks occur through the same channels that are impacted by a tight (accommodative) monetary policy shock • Examine the impact of the repo rate and LTV shocks on household balance sheets • Assess the response of LTVs to an unexpected positive current inflation expectations shock and inflation • Assess how deterioration in the inflation outlook leads to the LTV tightening • Understand the impact of LTV tightening shocks on price stability

Monetary Policy Report - January 2022

Japan’s encounter with deflation and near‐zero‐interest short‐term interest rates in the 1990s led to a surge in research on the implications of the zero lower bound (ZLB) on nominal interest rates for monetary policy around the end of that decade. Based on model simulations, the literature at that time identified a number of key implications of the ZLB (see Orphanides and Wieland [2000], Reifschneider and Williams [2000, 2002], Eggertsson and Woodford [2003], and references therein). First, with low inflation targets of the kind followed by many central banks, the ZLB will frequently be a binding constraint on monetary policy. That is, Japan’s example is not an outlier but rather a harbinger for the future. Second, at inflation targets of 1% or lower, lowering the inflation target comes at a cost of higher variability of output and inflation, although the effects on inflation variability are relatively small. This analysis provides an argument for maintaining a positive inflation target cushion above 1%. Third, in rare instances of severe prolonged recessions accompanied by deflation, standard open market operations will be insufficient to bring the inflation rate back to target, andalternative sources of stimulus to the economy, such as fiscal policy, will be needed. Fourth, central banks can significantly reduce the effects of the ZLB onmacroeconomic stability by modifying their policy actions and communication to the public when the ZLB threatens to constrain policy. Specifically, policies that cut rates aggressively when deflation is a risk and promise to temporarily target a higher rate of inflation following episodes where the ZLB binds were found to greatly reduce the effects of the ZLB in model simulations. In the decade since this researchwas initiated, the ZLB has gone froma theoretical issue applying to Japan to one that plagues many industrialized economies. Indeed, an era of overwhelming confidence in monetary policy’s power to tame the business cycle while delivering low and stable inflation has been replaced by fears that the global economy could

What is the role of perceived oil price shocks in inflation expectations?