AN EXAMINATION OF LINEAR AND NONLINEAR CAUSAL RELATIONSHIPS BETWEEN COMMODITY PRICES AND U.S. INFLATION

This article uses both linear and nonlinear causality tests to examine the causal relationships between changes in commodity prices and U.S. inflation. Prior to the Great Moderation, there is evidence that changes in commodity price indices linearly lead inflation. The stability of the causal relationship appears to vary over time with a stronger bivariate link established before the Great Moderation. Further, there is evidence of significant nonlinear causality from raw industrials and metals indices to inflation with most of this detected nonlinear relationship being captured using the Baba, Engle, Kraft, and Kroner asymmetric generalized autoregressive conditional heteroskedasticity model. This implies that the observed nonlinear Granger causality is largely driven by unanticipated shocks and volatility spillovers in the run‐up of commodity prices in late 2000. (JEL C18, C22, E31)     

Perceived inflation and expected future prices in different currencies

Five experiments were conducted to investigate whether perceived inflation and expected future prices are influenced by the nominal representation of increases in product prices in different currencies. In contrast to previous research demonstrating overestimates of the perceived inflation of product prices after the transition of the domestic German Mark to Euro [Greitemeyer, T., Schultz-Hardt, S., Traut-Mattausch, E., & Frey, D. (2005). The influence of price trend expectations on price trend perceptions: Why the Euro seems to make life more expensive? Journal of Economic Psychology, 26, 541–548; Traut-Mattausch, E., Schultz-Hardt, S., Greitemeyer, T., & Frey, D. (2004). Expectancy confirmation in spite of disconfirming evidence: The case of price increases due to the introduction of the Euro. European Journal of Social Psychology, 34, 739–760], the price increases were of normal magnitude (5% and 8%) and a larger set of prices was used including small weekly expenses, prices of durables, and rent. All experiments were conducted in Sweden (not member of the European monetary union) employing undergraduates who volunteered to participate in class settings without any financial compensation. The price increases were expressed in the same currency, either actual currencies (Swedish Crowns or Euros) or fictitious currencies with different units. In general inflation was underestimated, to a larger extent when the currency or the product prices were unfamiliar than familiar. It was also shown that product-specific price changes made it difficult to perceive inflationary price increases. Only marginal effects of currency unit were observed.     

SHOULD OIL PRICES RECEIVE SO MUCH ATTENTION? AN EVALUATION OF THE PREDICTIVE POWER OF OIL PRICES FOR THE U.S. ECONOMY

This paper evaluates the potential gains from using oil prices to forecast a variety of measures of inflation, economic activity, and monetary policy–related variables. With a few exceptions, oil prices do not have any predictive content for these variables. This finding is robust to the use of rolling forecast windows, the use of industry‐level data, changes in the forecast horizon, and allowing for nonlinearities. (JEL Q43, E37, C32)     

TO LEAN OR NOT TO LEAN AGAINST AN ASSET PRICE BUBBLE? EMPIRICAL EVIDENCE

Since the Global Financial Crisis of 2007–2009, economists are reconsidering the appropriate role of monetary policy towards equity bubbles. This paper contributes to these deliberations by estimating the response of the stock market to monetary policy tightening by using a Bayesian time-varying VAR model. By introducing the cyclically adjusted price/earnings ratio, we propose a method that estimates its fundamental and bubble components. We find that asset prices will initially fall and eventually rise again but without the risk of feeding the bubble. Counterfactual policy experiments provide additional evidence that monetary policy can lean against equity and housing prices. (JEL E50, E52, E58)     

UNION POWER,COLLECTIVE BARGAINING,AND OPTIMAL MONETARY POLICY

We study Ramsey policies and optimal monetary policy rules in a dynamic New Keynesian model with unionized labor markets. Collective wage bargaining and unions' monopoly power amplify inefficient employment fluctuations. The optimal monetary policy must trade off between stabilizing inflation and reducing inefficient unemployment fluctuations induced by unions' monopoly power. In this context the monetary authority uses inflation as a tax on union rents and as a mean for indirect redistribution. Results are robust to the introduction of imperfect insurance on income shocks. The optimal monetary policy rule targets unemployment alongside inflation. (JEL E0, E4, E5, E6)     

HEALTH CARE INFLATION AND ITS IMPLICATIONS FOR MONETARY POLICY

Motivated by recent findings on the cyclical movement of both health and health spending, we construct a general equilibrium model that distinguishes health care demand from the demand for other goods. Using this model, we are able to generate inflation dynamics and cyclicality of health that match the US data. When the model is subjected to an expansionary monetary policy shock, it yields different output and inflation responses compared with a two‐sector model with homogeneous demand. We show that the trade‐off between leisure and health spending plays an important role in model dynamics. The model further predicts different degrees of inflation stabilization across sectors when a shift in the monetary policy occurs. (JEL E52, E31, E32, I10)     

INFLATION DYNAMICS AND LABOR MARKET SPECIFICATIONS: A BAYESIAN DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM APPROACH FOR JAPAN'S ECONOMY

Which labor market specification is better able to describe inflation dynamics, a widely used sticky wage model or a recently investigated labor market search model? Using a Bayesian likelihood approach, we estimate these two models with Japan's data. This article shows that the labor market search model is superior to the sticky wage model in terms of both marginal likelihood and out‐of‐sample forecast performance, particularly regarding inflation. The labor market search model is better able to replicate the cross‐correlation among inflation, real wages, and output in the data. Moreover, in this model, real marginal cost is determined by both hiring cost and unit labor cost that varies with employment fluctuations, which gives rise to a high contemporaneous correlation between inflation and real marginal cost as represented in the New Keynesian Phillips curve. (JEL E24, E32, E37)     

LENDING RELATIONSHIPS AND MONETARY POLICY

Financial intermediation and bank spreads are the important elements in the analysis of business cycle transmission and monetary policy. We present a simple framework that introduces lending relationships, a relevant feature of financial intermediation that has been so far neglected in the monetary economics literature, into a dynamic stochastic general equilibrium model with staggered prices and cost channels. Our main findings are (a) banking spreads move countercyclically generating amplified output responses, (b) spread movements are important for monetary policymaking even when a standard Taylor Rule is employed, (c) modifying the policy rule to include a banking spread adjustment improves stabilization of shocks and increases welfare when compared to rules that only respond to output gap and inflation, and finally (d) the presence of strong lending relationships in the banking sector can lead to indeterminacy of equilibrium forcing the Central Bank to react to spread movements. (JEL E44, E52, G21)     

ALTERNATIVE P* MODELS OF INFLATION FORECASTS

This paper reevaluates the inflation forecast performance of M2-based P* models relative to other competing models over the period of 1970–96. Included in the comparative study are newly developed monetary aggregates, including M2+, MZM, and M2*, and direct treatments of velocity changes associated with recent developments in M2. Out-of-sample rolling-horizon forecast exercises suggest that the predictive accuracy of alternative P* model specifications relative to traditional inflation models is not robust to different subsamples. The switching forecast performance between money-based and output-based models across periods highlights the extent of structural instability in the inflation generating process. (JEL E3, E4, C2)     

INFLATION EXPECTATIONS AND CONSUMER SPENDING AT THE ZERO BOUND: MICRO EVIDENCE

Standard theoretical models predict that higher inflation expectations generate greater current consumer spending at the zero lower bound of interest rates. However, recent empirical studies using U.S. micro data find negative results for this relationship. We use micro data for Japan, which has experienced low interest rates for a prolonged period, to estimate ordered probit models with a variety of controls. We find robust evidence supporting the prediction of standard models: survey respondents with higher expected inflation tend to indicate that their household has increased real spending compared with 1 year ago but will decrease it in the future. This relationship appears to be stronger for asset holders and older people. (JEL E20, E21, E30, E31, E50, E52)     

ADVANCE PRODUCTION,INVENTORIES, AND MARKET POWER: AN EXPERIMENTAL INVESTIGATION

We report an experiment that assesses the effects of alterations in production conditions and product durability on market power in Bertrand‐Edgeworth duopolies. Static equilibrium analysis predicts that advance (rather than “to demand”) production raises prices, but does not affect profits. The further addition of a simple inventory option causes prices to fall and seller earnings to increase. Contrary to these predictions, we observe similar prices in baseline and advance production treatments, but lower profits given advance production. An inventory option reduces both prices and earnings. Results are driven by the treatments' effects on sellers' capacities to tacitly collude. (JEL C9, D4, L4)     

FINANCIAL FRICTIONS AND THE CHOICE OF EXCHANGE RATE REGIMES

This article provides a quantitative assessment of the role of financial frictions in the choice of exchange rate regimes. I use a two‐country model with sticky prices to compare different exchange rate arrangements. I simulate the model without and with borrowing constraints on investment, under monetary policy and technology shocks. I find that the stabilization properties of floating exchange rate regimes in face of foreign shocks are enhanced relative to fixed exchange rate in presence of credit frictions. In presence of symmetric and correlated shock, fixed exchange rates regimes can perform better than floating. This analysis can have important policy implications for accession countries joining the European Exchange Rate Mechanism II system and with high degrees of credit frictions. (JEL E3, E42, E44, E52, F41)     

WHAT'S SO FUNNY ABOUT MAKING MONETARY POLICY?

During their meetings, the members of the Federal Open Market Committee (FOMC) make monetary policy, but they also make each other laugh. This article studies the amount of laughter elicited by members of the FOMC during their meetings. The study finds that a member elicits more laughter if he or she expects higher inflation, other things being equal. This finding suggests that members may use humor to cope with the threat of inflation. (JEL E52, E58, C23)     

THE SWINGS OF U.S. INFLATION AND THE GIBSON PARADOX

In recent business cycles, U.S. inflation has experienced a reduction of volatility and a severe weakening in the correlation to the nominal interest rate (Gibson paradox). We examine these facts in an estimated dynamic stochastic general equilibrium model with money. Our findings point at a flatter New Keynesian Phillips Curve (higher price stickiness) and a lower persistence of markup shocks as the main explanatory factors. In addition, a higher interest‐rate elasticity of money demand, an increasing role of demand‐side shocks, and a less systematic behavior of Fed's monetary policy also account for the recent patterns of U.S. inflation dynamics. (JEL E32, E47)     

COMMODITY PRICES AND BANK LENDING

We analyze the transmission of changes in commodity prices to bank lending in a large sample of developing countries. A bank-level analysis shows that a fall in commodity net export prices is associated with a reduction of bank lending, particularly for commodity exporters and during episodes of terms-of-trade decline. We complement this analysis with loan-level data from a credit register, which allows us to identify the effect of a commodity price shock on the supply of credit, controlling for unobserved factors that could drive borrowers' credit demand. Results show that banks with relatively lower deposits and poor asset quality transmit the changes in commodity prices to lending more aggressively. (JEL F30, F34, G21, Q02)     

OUTPUT EFFECTS OF INFLATION WITH FIXED PRICE– AND QUANTITY–ADJUSTMENT COSTS

This article examines how the aggregate production varies with inflation when there are fixed price– and quantity–adjustment costs. It shows that such variation is determined by the elasticity of the firms’ marginal real revenue with respect to demand. The aggregate production decreases with inflation if this elasticity always exceeds minus unity, whereas the aggregate production increases with inflation if the elasticity is always less than minus unity. The aggregate production is independent of inflation in the special case that the elasticity always equals minus unity. The latter occurs if demand is derived from a log‐quadratic utility function. (JEL E31)     

Perceived inflation: The role of product accessibility and attitudes towards inflation

Little is known about the psychological mechanisms underlying judgments of perceived inflation as empirical evidence is sparse. In two studies, we investigated two factors that are expected to play a significant role in global judgments of perceived inflation: product accessibility and attitudes towards inflation. In Study 1 (N = 253), primed participants retrieved five products whose prices had increased (or decreased) in the past year before expressing a judgment of past inflation (versus non-primed participants with no retrieval task). In Study 2 (N = 101) participants were merely exposed to a series of products, and asked to estimate their frequency of purchase, before judging past inflation. In one condition, the prices of the majority of products had actually increased in the last year, while in another condition they had decreased. In both studies, attitudes towards inflation were also measured. Product priming consistently affected inflation judgments in the direction of an assimilation effect. Also, more negative attitudes towards inflation were associated with higher judgments of perceived inflation. Path analysis confirmed that both product accessibility and attitudes are potential bases for judgments of perceived inflation. These findings suggest that multiple psychological influences may underlie global judgments of perceived inflation.     

MONEY,OUTPUT, AND INFLATION IN THE LONGER TERM: MAJOR INDUSTRIAL COUNTRIES, 1880–2001

We study how fluctuations in money growth correlate with fluctuations in real output growth and inflation. Using band‐pass filters, we extract cycles from each time series that last 2–8 (business cycles) and 8–40 (longer‐term cycles) years. We employ annual data, 1880–2001 without gaps, for 11 industrial countries. Fluctuations in money growth do not play a systematic role at business cycle frequencies. However, money growth leads or affects contemporaneously inflation, but not real output growth, in the longer run. Also, formal break tests indicate no structural changes for the longer‐term money growth and inflation relationship, despite changes in policy regimes.(JEL E3)     

INFORMATION RIGIDITIES,INFLATION PERCEPTIONS,AND THE MEDIA: LESSONS FROM THE EURO CASH CHANGEOVER

The objective of theoretical models of information rigidities is to capture the fact that people are constrained in their ability to acquire and process all available information. Given that most people obtain their information about the economy from the media, press coverage of the economy may exert an influence on peoples' attitudes. This paper tests for this influence by examining consumers' inflation perceptions in the aftermath of the euro cash changeover, which serves as a natural experiment. Using a new data set, that quantifies the intensity and tone of media reports, we document that media reporting has had a statistically significant and economically meaningful impact on inflation perceptions and contributed to their sharp rise in the aftermath of the euro cash changeover and to the divergence between inflation perceptions and actual inflation rates. (JEL E53, D83)     

Expectations of inflation: The biasing effect of thoughts about specific prices

National surveys follow consumers’ expectations of future inflation, because these may directly affect the economic choices they make, indirectly affect macro-economic outcomes, and are considered in monetary policy. Yet, relatively little is known about how individuals form the inflation expectations they report on consumer surveys. Medians of reported inflation expectations tend to track official estimates of realized inflation, but show large heterogeneity between respondents, due to some expecting seemingly extreme inflation. We present two studies to examine whether individuals who consider specific price changes when forming their inflation expectations report more extreme and disagreeing inflation expectations due to focusing on specific extreme price changes. In Study 1, participants who were instructed to recall any price changes or to recall the largest price changes both thought of items for which price changes were perceived to have been extreme. Moreover, they reported more extreme year-ahead inflation expectations and showed more disagreement than did a third group that had been asked to recall the average change in price changes. Study 2 asked participants to report their year-ahead expectations of inflation, without first prompting them to recall specific price changes. Half of participants nevertheless thought of specific prices when generating their inflation expectations. Those who thought of specific prices reported more extreme and more disagreeing inflation expectations, because they were biased towards various items associated with more extreme perceived price changes. Our findings provide new insights into expectation formation processes and have implications for the design of survey-based measures of inflation.