Nominal stability over two centuries

Daniel Kaufmann

doi:10.1186/s41937-019-0033-7

Abstract

I assess the stability of the monetary environment in Switzerland over the past two centuries. In order to control for transitory measurement errors, in particular in nineteenth century data, I use an unobserved-components stochastic-volatility model to extract the permanent trends from several nominal variables. The descriptive analysis of these trends suggests that the current monetary regime, flexible inflation targeting, provided a relatively stable monetary environment. Although the trends are quite stable for the nineteenth century, the estimates are imprecise. We should therefore be cautious when characterizing metal currency regimes as providing a stable monetary environment. A discussion of the results shows that the apparent success of flexible inflation targeting poses new challenges for the implementation of monetary policy because the trend decline in inflation was associated with a trend decline in nominal interest rates.

Highlights

Nowadays, central banks usually announce to stabilize inflation around a numerical target
In order to abstract from short-term fluctuations and measurement errors, I extract a permanent trend using an extension of the unobserved component-stochastic volatility (UC-SV) model by Stock and Watson (2007), which has recently been proposed by Chan (2013)
The analysis reveals that flexible inflation targeting was associated with a historically stable monetary environment

Summary

Introduction

Central banks usually announce to stabilize inflation around a numerical target. No modern central bank currently targets the gold price in domestic currency, or issues a commodity money, despite that economic historians report that metal currency regimes provided a high degree of nominal stability and firmly anchored inflation expectations. In order to abstract from short-term fluctuations (over which the central bank has less control) and measurement errors (which would distort the analysis), I extract a permanent trend using an extension of the unobserved component-stochastic volatility (UC-SV) model by Stock and Watson (2007), which has recently been proposed by Chan (2013). The extended model allows for a moderately persistent transitory component with time-varying volatility. This property is important when analyzing historical data with possibly persistent measurement errors. This captures that transitory measurement errors and supply shocks were likely more important during the nineteenth

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