Aggregate Inflation Research Articles

The Persistence of Inflation in Switzerland: Evidence from Disaggregate Data

This paper investigates persistence of Swiss consumer price inflation using aggregate and disaggregate inflation data covering 1983{2008. We document that persistence of sectoral inflation rates is below persistence of aggregate inflation. Our main finding is that inflation persistence significantly declines in the early 1990s. An estimated factor model reveals that inflation persistence stems from a persistent component that is common to inflation rates across sectors. Both the relevance and the persistence of the common component decline in the 1990s. Depending on the sample period and aggregation level, 70 to 90 percent of the variance in sectoral inflation rates is accounted for by short-lived sectoral factors.

What Lies Beneath: What Can Disaggregated Data Tell Us about the Behaviour of Prices?

This paper uses a factor-augmented vector autoregression technique to examine the role that macroeconomic and sector-specific factors play in UK price fluctuations at the aggregate and disaggregated levels. Macroeconomic factors are less important for disaggregated prices than aggregate ones. There also appears to be significant aggregation bias - the persistence of aggregate inflation series is much higher than the underlying persistence across the range of disaggregated price series. Our results suggest that monetary policy affects relative prices in the short to medium term, and that the degree of competition within industries plays a role in determining pricing behaviour.

Estimating DSGE Models with Long Memory Dynamics

Recent literature claims that key variables such as aggregate productivity and inflation display long memory dynamics. We study the implications of this high degree of persistence on the estimation of Dynamic Stochastic General Equilibrium (DSGE) models. We show that long memory data produce substantial bias in the deep parameter estimates when a standard Kalman Filter-MLE procedure is used. We propose a modification of the Kalman Filter to effectively deal with this problem. The augmented Kalman Filter can consistently estimate the model parameters as well as produce more accurate out-of-sample forecasts compared to the standard Kalman filter.

Welfare Costs of Inflation in a Menu Cost Model

Recent years have seen substantial prog? ress in our understanding of pricing decisions at the micro level. Access to large-scale data sources on prices of individual products has given us rich information on how frequently prices change, by what magnitude, and how the aggregation of price changes in individual firms maps into aggregate inflation (see, among many others, Mark Bils and Peter J. Klenow 2005). These facts about price movements are a key input in recent quantitative models of the aggre? gate effects of nominal rigidities (e.g., Mikhail Golosov and Robert E. Lucas 2007). In this paper, we use both the new facts and the new quantitative models to revisit an old question, namely, that of quantifying the welfare benefits of low inflation. Our model includes two

HOUSE PRICES IN THE MEASUREMENT OF INFLATION IN THE EURO AREA

An important element of the current monetary policy debate in Europe is the question of if and how house prices should be included in the harmonized index of consumer prices (HICP). This paper uses a signal extraction approach to inflation measurement to illustrate the impact of including house prices when the aggregate inflation measure is constructed by assigning weights to individual price series based on their signal‐to‐noise ratio. The inclusion of house prices in the HICP in this manner does not materially impact the appropriate stance of monetary policy. (JEL E31, E52, E58)

Inflation, price dispersion, and market structure

In this paper, we use a novel data set containing prices from bazaars, convenience stores, and supermarkets in Istanbul to re-examine the relationship between price dispersion and inflation. Although existing evidence is mixed, we find positive and significant relationships between dispersion, on the one hand, and lagged dispersion and unexpected product-specific inflation on the other. We also find evidence that dispersion is initially decreasing in anticipated aggregate inflation but is eventually increasing. Finally, average price duration and dispersion are lowest in the bazaar. This is intuitive, since menu and search costs should be minimal in that market structure.

Dynamic pricing and imperfect common knowledge

Introducing private information into the dynamic pricing decision of firms by adding an idiosyncratic component to marginal cost can help explain two stylised facts about price changes: Aggregate inflation responds gradually and with inertia to shocks at the same time as individual price changes can be large. The inertial behaviour of inflation is driven by privately informed firms strategically ‘herding’ on the public information contained in the observations of lagged aggregate variables. The model also matches the average duration between price changes found in the data and it nests the standard New-Keynesian Phillips Curve as a special case. To solve the model, the paper derives an algorithm for solving a class of dynamic models with higher order expectations.

A Comparison of Measures of Core Inflation

The ability of central banks to differentiate between permanent and transitory price movements is critical for the conduct of monetary policy. The importance of gauging the persistence of price changes in a timely manner has led to the development of measures of underlying, or core, inflation that are designed to remove transitory price changes from aggregate inflation data. Given the usefulness of this information to policymakers, there is a surprising lack of consensus on a preferred measure of U.S. core inflation. This article examines several proposed measures of core inflation - the popular ex food and energy series, an ex energy series, a weighted median series, and an exponentially smoothed series - to identify a best measure. The authors evaluate the measures' performance according to criteria such as ease of design and accuracy in tracking trend inflation, as well as explanatory content for within-sample and out-of-sample movements in aggregate CPI and PCE inflation. The study reveals that the candidate series perform very differently across aggregate inflation measures, criteria, and sample periods. The authors therefore find no compelling evidence to focus on one particular measure of core inflation, including the series that excludes food and energy prices. They attribute their results to the design of the individual measures and the measures' inability to account for variability in the nature and sources of transitory price movements.

Fast Micro and Slow Macro: Can Aggregation Explain the Persistence of Inflation?

An aggregation exercise is proposed that aims at investigating whether the fast average adjustment of the disaggregate inflation series of the euro area CPI translates into the slow adjustment of euro area aggregate inflation. We first estimate a dynamic factor model for 404 inflation sub-indices of the euro area CPI. This allows to decompose the dynamics of inflation sub-indices in two parts: one due to a common macroeconomic shock and one due to sector specific idiosyncratic shocks. Although idiosyncratic shocks dominate the variance of sectoral prices, one common factor, which accounts for 30 per cent of the overall variance of the 404 disaggregate inflation series, is the main driver of aggregate dynamics. In addition, the heterogenous propagation of this common shock across sectoral inflation rates, and in particular its slow propagation to inflation rates of services, generates the persistence of aggregate inflation. We conclude that the aggregation process explains a fair amount of aggregate inflation persistence.

Aggregating Phillips Curves

The New Keynesian Phillips Curve is at the centre of two raging empirical debates. First, how can purely forward looking pricing account for the observed persistence in aggregate inflation. Second, price-setting responds to movements in marginal costs, which should therefore be the driving force to observed inflation dynamics. This is not always the case in typical estimations. In this paper, we show how heterogeneity in pricing behaviour is relevant to both questions. We detail the conditions under which imposing homogeneity results in overestimating a backward-looking component in (aggregate) inflation, and underestimating the importance of (aggregate) marginal costs for (aggregate) inflation. We provide intuition for the direction of these biases, and verify them in French data with information on prices and marginal costs at the industry level. We show that the apparent discrepancy in the estimated duration of nominal rigidities, as implied from aggregate or microeconomic data, can be fully attributable to a heterogeneity bias.

Inflation, Price Dispersion, and Market Structure

In this paper, we use a novel data set containing prices from bazaars, convenience stores, and supermarkets in Istanbul to re-examine the relationship between price dispersion and inflation. Although existing evidence is mixed, we find positive and significant relationships between dispersion, on the one hand, and lagged dispersion and unexpected product-specific inflation on the other. We also find evidence that dispersion is initially decreasing in anticipated aggregate inflation but is eventually increasing. Finally, average price duration and dispersion are lowest in the bazaar. This is intuitive, since menu and search costs should be minimal in that market structure.

U.S. Wage and Price Dynamics: A Limited Information Approach

This paper analyzes the dynamics of prices and wages using a limited information approach to estimation. I estimate a two-equation model for the determination of prices and wages derived from an optimization-based dynamic model in which both goods and labor markets are monopolistically competitive; prices and wages can be reoptimized only at random intervals; and, when prices and wages are not reoptimized, they can be partially adjusted to previous-period aggregate inflation. The estimation procedure is a two-step minimum distance estimation that exploits the restrictions imposed by the model on a time-series representation of the data. In the first step, I estimate an unrestricted autoregressive representation of the variables of interest. In the second, I express the model solution as a constrained autoregressive representation of the data and define the distance between unconstrained and constrained representations as a function of the structural parameters that characterize the joint dynamics of inflation and labor share. This function summarizes the cross-equation restrictions between the model and the time-series representations of the data. I then estimate the parameters of interest by minimizing a quadratic function of that distance. I find that the estimated dynamics of prices and wages track actual dynamics quite well and that the estimated parameters are consistent with the observed length of nominal contracts.

Disaggregate evidence on the persistence of consumer price inflation

AbstractThis paper uses disaggregate inflation data spanning all of consumption to examine: (i) the persistence of disaggregate inflation relative to aggregate inflation; (ii) the distribution of persistence across consumption sectors; and (iii) whether persistence has changed. Assuming mean inflation to be unchanged, disaggregate persistence inflation is consistently below aggregate persistence. Taking into account an early 1990s shift in mean inflation identified by break tests yields much lower estimates of both aggregate and disaggregate persistence for 1984–2002. But with the mean break, average disaggregate persistence is actually as great as aggregate inflation persistence. A factor model provides a natural framework for interpreting the relationship between aggregate and disaggregate persistence. Copyright © 2006 John Wiley & Sons, Ltd.

Sectoral and Aggregate Inflation Dynamics in the Euro Area

This paper synthesises the implications of recent statistical evidence regarding inflation persistence in the euro area. For aggregate data, the degree of inflation persistence appears to be very high for sample periods spanning multiple decades but falls dramatically once we allow for time variation in the mean level of inflation; furthermore, the timing of these breaks in mean generally coincides with observed shifts in the monetary policy regime. Finally, sectoral inflation series exhibit much less persistence than aggregate inflation, mainly because of the influence of transitory sector-specific shocks. (JEL: E31, C22, C43)

A Review of Core Inflation and an Evaluation of its Measures

This paper provides a review of the concept of core inflation and evaluates the performance of several proposed measures. We first consider the rationale of a central bank in setting its inflation goal in terms of a selected rate of consumer price growth and the use of a core inflation measure as a means of achieving this long-term policy objective. We then discuss desired attributes of a core measure of inflation, such as ease of design, accuracy in tracking trend inflation, and predictive content for future movements in aggregate inflation. Using these attributes as criteria, we evaluate several candidate series that have been proposed as core measures of consumer price index (CPI) inflation and personal consumption expenditure (PCE) inflation for the United States. The candidate series are inflation excluding food and energy, inflation excluding energy, and median inflation, as well as exponentially smoothed versions of aggregate inflation and the aforementioned individual series. For PCE inflation, we examine quarterly data starting in 1959. Unlike previous research, we confine our analysis to the methodologically consistent CPI index, which is only available starting in 1978. We find that most of the candidate series, including the familiar ex-food and energy measure, demonstrate the ability to match the mean rate of aggregate inflation and track movements in its underlying trend. In the within-sample analysis, we find that core measures derived through exponential smoothing, in combination with simple measures of economic slack, have substantial explanatory content for changes in aggregate inflation several years in advance. In the out-of-sample analysis, however, we find that no measure performs consistently well in forecasting inflation. Moreover, we document evidence of some parameter instability in the estimated forecasting models. Taken together, our findings lead us to conclude that there is no individual measure of core inflation that can be considered superior to other measures.

Competition, Productivity and Prices in the Euro Area Services Sector

This paper analyses the degree of competition in the euro area services sector and its effects on labour productivity and relative prices in that sector over the period 1980-2003. The importance of the euro area services sector has significantly increased over time; it now accounts for around 70% of the euro area's total nominal value added and employment. Labour productivity growth across the euro area services industries appears to be characterised by a high degree of diversity and the level of services inflation is on average higher than aggregate inflation. Investigating several proxies of market competition for the non-financial business services, the paper finds that limited competition in services tends to hamper labour productivity growth in the services sector. Moreover, results tend to suggest that measures aimed at increasing services market competition may have a dampening impact on relative price changes in some services sectors and thus temporarily on aggregate inflation.

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.

Inflation Measurement

Inflation measurement is the process through which changes in the prices of individual goods and services are combined to yield a measure of general price change. This paper discusses the conceptual framework for thinking about inflation measurement and considers practical issues associated with determining an inflation measure's scope; with measuring individual prices; and with combining these individual prices into a measure of aggregate inflation. We also discuss the concept of "core inflation," and summarize the implications of inflation measurement for economic theory and policy.

The Role of Real Wage Rigidity and Labor Market Frictions for Unemployment and Inflation Dynamics

In this paper we incorporate a labor market with matching frictions and wage rigidities into the New Keynesian business cycle model. In particular, we analyze the effect of a monetary policy shock and investigate how labor market frictions affect the transmission process of monetary policy. The model allows real wage rigidities to interact with adjustments in employment and hours affecting inflation dynamics via marginal costs. We find that the response of unemployment and inflation to an interest rate innovation depends on the degree of wage rigidity. Generally, more rigid wages translate into more persistent movements of aggregate inflation. Moreover, the impact of a monetary policy shock on unemployment and inflation depends also on labor market fundamentals such as bargaining power and the flows in and out of employment.

Stable Price Level and Changing Prices

The paper investigates the relationship between relative price movements and changes in the aggregate price level using monthly data on Finland's Consumer Price Index and its components from the period covering the past eight and a half years. This was a period of very low inflation. The rate of growth in the aggregate price level was occasionally very close to zero. The paper shows that declining nominal prices were a rather common phenomenon during this period of low or no inflation. The declining prices cannot, however, be explained by lack of demand or any generalized deflationary tendencies. Hence, the downward rigidity of nominal prices has not prevented relative price adjustments under price stability. The paper develops a new method for looking at the composition of inflation and illustrating how relative price dynamics interact with changes in the aggregate price level. The correlation of relative price variability and aggregate inflation has been negligible, but the correlation between the skewness of price change distribution and aggregate inflation is high. This is in accordance with the predictions of the menu cost models. A significant proportion of the relative price changes appear to have been persistent, suggesting the dominance of productivity and other supply shocks.