Official Inflation Research Articles

Did Inflation Really Soar After the Euro Cash Changeover? Indirect Evidence from ATM Withdrawals

The introduction of the euro notes and coins in the first two months of 2002 was followed by a lively debate on the alleged inflationary effects of the new currency. In Italy, as in the rest of the euro area, survey-based measures signaled a much sharper rise in inflation than measured by the official price indices, whose quality was called into question. In this paper we gather indirect evidence on the behavior of prices from the analysis of cash withdrawals from ATM and their determinants. Since these data do not rely on official inflation statistics, they provide an independent check for the latter. We present a model in which the relationship between aggregate ATM withdrawals and aggregate expenditure is not homogenous of degree one in the price level, a prediction which is strongly supported by the data. This feature allows us to test the hypothesis that, after the introduction of the euro notes and coins, consumer prices underwent an increase not recorded by official inflation statistics. We do not find evidence in support of this hypothesis.

An Inflation Goal with Multiple Reference Measures

Most inflation-targeting central banks express their inflation objective in terms of a range for a single official inflation measure but generally have not clarified the meaning of the ranges and their implications for policy responses. In formulating policy, all central banks monitor multiple inflation indicators. This paper suggests an alternative approach to communicating an inflation goal: announcing point-values, rather than ranges, for a few key reference measures of inflation that are used in making policy. After reviewing and extending relevant theoretical and empirical studies, the paper argues that the alternative approach could more accurately reflect the concerns of policymakers and provide a better accountability structure for monetary policy performance.

An Inflation Goal with Multiple Reference Measures

Most inflation-targeting central banks express their inflation objective in terms of a range for a single official inflation measure but generally have not clarified the meaning of the ranges and their implications for policy responses. In formulating policy, all central banks monitor multiple inflation indicators. This paper suggests an alternative approach to communicating an inflation goal: announcing point-values, rather than ranges, for a few key reference measures of inflation that are used in making policy. After reviewing and extending relevant theoretical and empirical studies, the paper argues that the alternative approach could more accurately reflect the concerns of policymakers and provide a better accountability structure for monetary policy performance.

Macroeconomic implications of low inflation in the euro area

The ECB’s official inflation objective is an annual increase in the Harmonized Index of Consumer Prices (HICP) of below 2% in the medium run. Many commentators argue that there is a deflationary bias in this definition, because the lower bound of the inflation objective is not clearly specified. It is also often claimed that the ECB’s ambitious inflation objective increases the risk of a liquidity trap and may give rise to higher long-term unemployment in the presence of rigid labor markets in the euro area. Recent experience suggests, however, that concerns about the lower bound are unwarranted, because headline inflation was barely below 2%. Fears of a liquidity trap or higher unemployment also appear not to be supported by the empirical evidence. Another popular argument holds that the common monetary policy will lead to increasing economic divergences in the euro area as national inflation differentials translate into national real-interest-rate differentials. We show that aggregate demand in euro-area countries is significantly affected by the euro-area real interest rate, but not by national real-interest-rate differentials.

Extracting Inflation from Stock Returns to Test Purchasing Power Parity

Relative purchasing power parity (PPP) holds for pure price inflations, which affect prices of all goods and services by the same proportion, while leaving relative prices unchanged. Pure price inflations also affect nominal returns of all traded financial assets by exactly the same amount. Recognizing that relative PPP may not hold for the official inflation data constructed from commodity price indices because of relative price changes and other frictions that cause prices to be \sticky, we provide a novel method for extracting a proxy for realized pure price inflation from stock returns. We find strong support for relative PPP in the short run using the extracted inflation measures.

Extracting Inflation from Stock Returns to Test Purchasing Power Parity

Relative purchasing power parity (PPP) holds for pure price inflations, which affect prices of all goods and services by the same proportion, while leaving relative prices unchanged. Pure price inflations also affect nominal returns of all traded financial assets by exactly the same amount. Recognizing that relative PPP may not hold for the official inflation data constructed from commodity price indices because of relative price changes and other frictions that cause prices to be “sticky,” we provide a novel method for extracting a proxy for realized pure price inflation from stock returns. We find strong support for relative PPP in the short run using the extracted inflation measures.

Trade Elasticities and Market Expectations in Brazil

This paper provides econometric estimates of trade elasticities for Brazil obtained through cointegration and vector auto regression models and controlling for the effects of exchange rate volatility, capacity utilization, and changes in import tariffs. The results suggest that (i) recent market expectations may have been unduly pessimistic regarding the responsiveness of Brazil's trade flows to the real exchange rate, but (ii) the GDP growth rates targeted by the new government may put downward pressure on the exchange rate and thus render the achievement of official inflation targets considerably more difficult if structural reforms are not implemented.

Does the Chinese official CPI underestimate inflation?1

This paper examines the behaviour of the Chinese official CPI relative to a market-based index. The empirical results indicate that the official index underestimates the actual inflation rate and that the bias is time-varying. The biasedness of the official index is attributed to covert price rises induced by the presence of price controls and quantity rationing.

The hybrid system and continued marketization of the Chinese economy

By analyzing the systemic causes of official corruption and reform-induced inflation, this paper explores the future path of changes in the Chinese economic system. This analysis suggests that as a product of arbitrage opportunities in resource allocation, official corruption can only be eliminated as the hybrid system evolves into a predominantly market economy. Furthermore, albeit necessary, price reforms alone are not sufficient to create a competitive market economy. Both ownership reforms and structural changes caused by new market entries are needed. It is suggested that the hybrid is a system of transition and the marketization of the Chinese economy will continue as the non-state-owned sector increases its share in the economy.

THE AUTUMN STATEMENT

The Treasury's forecast, published with the Autumn Statement, has been widely heralded as showing a surprisingly cheerful picture for next year as far as both output and inflation are concerned. In fact it is close to the forecast which we produced in October. Here we compare the two forecasts and then consider how our forecast is affected when we adopt the Treasury assumptions on asset sales and the exchange rate. We find that the Treasury is more optimistic than we are on investment and that holding the exchange rate ‐ which is needed to produce the official inflation forecast ‐ requires rather higher interest rates than we assumed in October and this widens the gap between our forecast for GDP and the Treasury's forecast.We also consider how the government should respond to lower North Sea oil revenues. Taking a permanent income approach, we suggest that the PSBR should be allowed to rise by £2bn on this basis. The same approach, however, suggests that an extra £71/2bn of asset sales should be used to cut the PSBR not taxes. On balance therefore this analysis indicates that next year's PSBR target should be lowered by £1/2bn from the £71/2 bn contained in the 1985 MTFS.

Assumptions–Central Forecast

We continue to make our best guesses about likely policy developments rather than assuming ‘unchanged’ policies. In the central forecast we assume that the broad thrust of policy is unchanged, i.e. we have made the technical assumption that the present government is returned in the next General Election. But, because an election must be held within the next 15 months, we also consider the medium‐term prospects under alternative economic policies. (For details see p. 19.) In the central forecast. e herefore. we assume that policy will continue to be guided‐though not completely determined‐by an extended Medium‐ Term Financial Strategy (MTFS). For 1983‐4 the MTFS requires the PSBR to be 23/4% per cent of GDP at market prices. Given official inflation and output forecasts, the Chancellor is therefore aiming for a 1983‐4 PSBR of £8bn (Autumn Statement, p. 13). In the central forecast. however, we have assumed that the Budget of 15 March will give greater weight to the political objectives of cutting income tax and maintaining the attack on inflation, even if this implies slippage from the MTFS targets. Specifcally we have assumed that the standard rate of income tax will be cut by lp. that personal tax allowances will be raised by 12 per cent and that indirect taxes will be raised by only half the amount required for full revalorisation. This amounts to a total tax giveaway (compared with unchangedpolicy) of £1 1/2 and results in a PSBR of just over £9bn. 3.1 per cent of GDPat market prices.