Steady-state Inflation Rate Research Articles

Is the Backward-Looking Component Important in a New Keynesian Phillips Curve?

New Keynesian Phillips curves (NKPC) have recently been modified to include additionallagsofinflationinthespecificationinordertocapturetheconsiderablepersistenceinpostwarU.S.inflation. Furthermore, many researchers have agreed on the existence of structural changes in thepersistence of inflation. Continuing with these literatures, we investigate the nature of structuralchanges in the hybrid NKPC and reconsider the role of the backward-looking component in theNKPC, taking into account the possibility of structural changes in the steady-state inflation rate.Our empirical results show multiple structural breaks in the NKPC in 1974 and 1982. Accountingfor these structural changes, the backward-looking component is no longer significant throughoutthe whole sample period. In other words, the significant role of the backward-looking componentin the earlier literature might be spuriously capturing the structural changes in the steady-stateinflation rate. Thus, U.S. inflation dynamics are well explained by a pure NKPC if we take intoaccount the possibility of structural changes in the steady-state inflation rate.

Comment on Argia M. Sbordone “Inflation persistence: Alternative interpretations and policy implications”

Let me begin with a summary of this interesting paper, before giving some comments. The paper builds on Sbordone’s earlier work with Tim Cogley (Cogley and Sbordone, 2005, 2006—referenced as CS hereafter). In that work, CS developed a macro-model with a time-varying inflation trend. As in a familiar version of Calvo pricing with indexing, CS assumed that firms that do not reoptimize partially index to the previous period’s inflation rate. It is standard to log linearize around a zero steady-state inflation rate. This would lead to a linear equation with a lag of inflation in the Phillips curve (see, e.g., Woodford, 2003):

Capital and Macroeconomic Instabilty in a Discrete-Time Model With Forward-Looking Interest Rate Rules

The authors establish the necessary and sufficient conditions for local real determinacy in a discrete-time production economy with monopolistic competition and a quadratic price adjustment cost under forward-looking policy rules, for the case where capital is in exogenously fixed supply and the case with endogenous capital accumulation. Using these conditions, they show that (i) indeterminacy is more likely to occur with a greater share of payment to capital in value-added production cost; (ii) indeterminacy can be more or less likely to occur with constant capital than with variable capital; (iii) indeterminacy is more likely to occur when prices are modelled as jump variables than as predetermined variables; (iv) indeterminacy is less likely to occur with a greater degree of steady-state monopolistic distortions; and (v) indeterminacy is less likely to occur with a greater degree of price stickiness or with a higher steady-state inflation rate. In contrast to some existing research, the authors' analysis indicates that capital tends to lead to macroeconomic instability by affecting firms' pricing behavior in product markets rather than households' arbitrage activity in asset markets even under forward-looking policy rules.

Capital and macroeconomic instability in a discrete-time model with forward-looking interest rate rules

We establish the necessary and sufficient conditions for local real determinacy in a discrete-time production economy with monopolistic competition and a quadratic price adjustment cost under forward-looking policy rules, for the case where capital is in exogenously fixed supply and the case with endogenous capital accumulation. Using these conditions, we show that (i) indeterminacy is more likely to occur with a greater share of payment to capital in value-added production cost; (ii) indeterminacy can be more or less likely to occur with constant capital than with variable capital; (iii) indeterminacy is more likely to occur when prices are modelled as jump variables than as predetermined variables; (iv) indeterminacy is less likely to occur with a greater degree of steady-state monopolistic distortions; and (v) indeterminacy is less likely to occur with a greater degree of price stickiness or with a higher steady-state inflation rate. In contrast to some existing research, our analysis indicates that capital tends to lead to macroeconomic instability by affecting firms’ pricing behavior in product markets rather than households’ arbitrage activity in asset markets even under forward-looking policy rules.

Multiple reserve requirements in a monetary growth model

This paper considers a monetary growth model in which banks provide liquidity, and in which a government finances a deficit by printing money and selling bonds. In this context, I examine the possibility that the government may want to impose binding reserve requirements on banks' holdings of both money and government bonds. Conditions are established under which doing so increases steady state welfare and reduces the scope for indeterminacies. Furthermore, under a binding system of multiple reserve requirements we have that money is superneutral. On the other hand, if reserve requirements are imposed on cash holdings alone, increases in the steady state inflation rate adversely affect capital accumulation and long run real activity. Thus systems of multiple binding reserve requirements can insulate real activity from the consequences of inflationary taxation.

Nominal Exchange Rate Anchoring Under Inflation Inertia

This paper develops a theory of inflation inertia based on forward looking staggered price setting in the nontradable goods sector of a small open economy. Unlike current theories of sticky prices, transitions to a lower steady state inflation rate take time even if they are fully credible, and they are associated with significant output losses in nontradables There is a welfare trade-off between these output losses and the gains from smaller inflationary distortions. Gains exceed losses for most calibrations. The optimal steady state is the Friedman rule.

Monetary policy and multiple equilibria in a cash-in-advance economy

This article shows that whether active interest rate rules can generate equilibrium uniqueness or indeterminacy depends upon: (1) the magnitude of the intertemporal elasticity of substitution, and (2) the value of the steady state inflation rate. In particular, if the intertemporal elasticity is smaller than one, then an active interest rate rule renders equilibrium indeterminate when the steady state inflation rate is sufficiently high, and ensures uniqueness of equilibrium when it is sufficiently low.

Money, Banking, and Capital Formation

We consider a monetary growth model in which banks arise to provide liquidity. In addition, there is a government that issues not only money, but interest-bearing bonds; these bonds compete with capital in private portfolios. When the government fixes a constant growth rate for the money stock, we show that there can exist multiple nontrivial monetary steady states. One of these steady states is a saddle, while the other can be a sink. Moreover, paths approaching a steady state can display damped endogenous fluctuations, and development trap phenomena are common. Across different steady states, low capital stocks are associated with high nominal interest rates; the latter signal the comparative inefficiency of the financial system. Also, increases in the steady state inflation rate can easily reduce the steady state capital stock.Journal of Economic LiteratureClassification Numbers: E13, E44, E50, G20, O16.

The Phillips curve, parameter instability and the Lucas critique

Empirical estimation of Phillips curve relationships typically indicates the presence of parameter instability. This is argued to be due to the fact that the parameters of these equations are reduced form rather than structural parameters. Estimation of a Phillips curve model by methods which allow for time-varying parameters permits investigation of the nature and timing of the structural breaks which generate instability. This paper estimates such a model by the Kalman filter using quarterly data over the period 1972.4 to 1993.3. We find evidence of a gradual decline in the private sector's assessment of the steady-state inflation rate during the 1980s, but little evidence of the sort of dramatic regime shift predicted by some of the more extreme rational expectations models.

External debt and fiscal adjustment in anti-inflation programs

This note examines the effect of fiscal adjustments on the steady-state rate of inflation when the government is externally indebted. It is shown that the effect of such adjustments depends on the real exchange rate movements associated with each method used to reduce the budget deficit, since real exchange rate movements feedback to the government budget.

Money, Banking, and Capital Formation

We consider a monetary growth model in which banks arise to provide liquidity. In addition, there is a government that issues not only money, but interest-bearing bonds; these bonds compete with capital in private portfolios. When the government fixes a constant growth rate for the money stock, we show that there can exist multiple nontrivial monetary steady states. One of these steady states is a saddle, while the other can be a sink. Paths approaching these steady states can display damped endogenous fluctuations, and development trap phenomena are common. Across different steady states, low capital stocks are associated with high nominal interest rates; the latter signal the comparative inefficiency of the financial system. Also, increases in the steady state inflation rate can easily reduce the steady state capital stock.

CAN A CENTRAL BANK GO BUST?

Central banks publish profit figures that are invariably well below the amounts implied by calculations of their seigniorage revenue. Most of the difference is due to the impairment of central bank balance sheets by the acquisition of substandard assets and of liabilities not matched by assets of equal value. In the limit, a central bank can go bust when it has acquired liabilities of greater market value than the present value of its seigniorage revenue calculated for any steady-state inflation rate. An insolvent central bank can continue to service its liabilities only through accelerating inflation. Copyright 1992 by Blackwell Publishers Ltd and The Victoria University of Manchester

External Shocks and Inflation in Developing Countries Under a Real Exchange Rate Rule

This paper shows that the response of inflation to external shocks is very different when the authorities target the real exchange rate than when they follow a fixed exchange rate or a preannounced crawling peg. Specifically, shocks that would have no effect on the steady-state inflation rate under a fixed exchange rate are either inflationary or deflationary under a real exchange rate rule. Moreover, irrespective of the degree of capital mobility, the authorities will find it difficult to mitigate the destabilizing effects of real shocks on the price level by using monetary policy, except possibly in the very short run.

External Shocks and Inflation in Developing Countries Under a Real Exchange Rate Rule

This paper shows that the response of inflation to external shocks is very different when the authorities target the real exchange rate than when they follow a fixed exchange rate or a preannounced crawling peg. Specifically, shocks that would have no effect on the steady-state inflation rate under a fixed exchange rate are either inflationary or deflationary under a real exchange rate rule. Moreover, irrespective of the degree of capital mobility, the authorities will find it difficult to mitigate the destabilizing effects of real shocks on the price level by using monetary policy, except possibly in the very short run.

Sustainability of Macroeconomic Policies, Inflation Targeting, and Crowding out

Sustainability of Macroeconomic Policies, Inflation Targeting, and Crowding out

INFLATION AND NON-NEUTRALITIES IN THE TAXATION OF CORPORATE SOURCE INCOME

IN the literature on the welfare effects of inflation one view which has developed is that it is not inflation per se that is harmful but rather its interaction with pre-existing institutions which were not designed for an inflationary world. Particular emphasis has been given to the failure to index the tax system. The purpose of the present paper is to examine one such interaction and consider the view that high inflation rates combined with unindexed systems of personal and corporate taxation have imposed substantially higher tax burdens on corporate source income. The general background to this issue is the substantial decline in real share values over much of the 1970's and early 1980's in almost all countries where major stock exchanges exist (the one exception appears to be Japan). In the UK the Financial Times index of industrial ordinary shares (measured as an average of working days) rose by only 66.7% between 1975 and 1981 while the Retail Price Index increased by 118.9% over the same period. Given some link between share prices and investment it is possible to argue that the decline in the real value of equities will have been accompanied by a reduction in the level of the capital stock below that which would otherwise have been attained. This view has been argued most forcefully (for the US) by Feldstein (1980a, 1980b), who suggests that the long-run reduction in the real share value and capital stock of US non-financial corporations as a result of the interaction of inflation and an unindexed tax system over the 1970's is of the order of 20-30%. These conclusions have been challenged by Hendershott (1981), again for the US, who argues that on the basis of tax biases alone real share prices should have increased with the inflation rate in the short run whilst being independent of inflation in the long run. Our concern here is to examine the specific question of how changes in the fully anticipated steady state rate of inflation affect share prices and the corporate capital stock when the tax system is unindexed, and to do so with particular reference to the UK. There are many possible explanations of the decline in real equity values: there may have been a fall in pre-tax profitability; high inflation rates may have made equity a more risky investment; investors may have made valuation errors. In this paper, however, we are

Money-financed Fiscal Policy in a Growing Economy

The paper examines the trajectories of the economic variables when government expenditures are financed by changes in the money stock. It is shown that government budget balance is not a condition for equilibrium. If the nominal rate of interest changes by about as much as the expected rate of inflation, a rise in real government purchases per capita has the following effects: There will be a positive impact upon output per capita but steady-state output per capita and the capital intensity will decline, and there will be a rise in the inflation tax on real balances and steady-state rate of inflation.

The Inefficiency of Interest-bearing National Debt

The coexistence of money and default-free interest-bearing government bonds is explained by transaction costs; the private sector absorbs money with less real difficulty than it absorbs bonds. Under the assumption that the costs of issuing money and issuing bonds are identical, it follows that the presence of government bonds is inefficient. Further, the steady-state inflation rate is higher with bond financing of a given real deficit because there is less net output, less real saving, and hence the need for the government to inflate faster. This is demonstrated in a version of Samuelson's pure consumption-loans model.

Money as a medium of exchange and monetary growth in an underdevelopment context

This paper constructs a neoclassical monetary growth model applicable to less developed economies, in that (1) the economy is assumed to be labour-surplus (as a result of which its steady-state growth rate is an endogenous variable), and (2) differential savings propensities on the part of profit- and wage-earners are postulated. The model predicts that an increase in the rate of monetary expansion increases the steady-state rate of inflation, increases the capital-labour ratio, reduces the money-labour ratio, and reduces the steady-state growth rate. Because of this last-mentioned fact, an inflationary policy is held to be unfavorable to economic development, despite the fact that it increases the capital-labour ratio. Some implications of the analysis for the well-known ‘choice of techniques’ problem are also discussed.