The ECB’s new inflation target from a short- and long-term perspective

The ECB’s target was recently revised, specifying that the 2%-inflation-rate threshold must be applied symmetrically and with a medium-term orientation. In the current phase, characterized by high inflation rates and a growing risk of stagnation in the euro area, this revision of the monetary policy strategy is crucial for explaining the recent decisions of the ECB and forecasting their possible evolution. However, monetary policy can only become one of many policy tools in the euro area. Therefore, there is room for a compelling policy mix necessary to control excessive inflation and to support the medium-term sustainable growth of the European economy.     

Does inflation bias stabilize real growth? Evidence from Pakistan

The motive of a typical discretionary central banker to accommodate excess inflation (inflation bias) is either to stabilize real growth or to spur it beyond natural rate. To what extent inflation bias helps to materialize this intention warrants empirical investigation. A more direct empirical probe into this issue, however, requires observable inflation bias indicators, which we model through desirable and threshold inflation rates as well as their respective society’s preferences. While examining the effects of inflation bias for a typical case of the discretionary monetary policy strategy of Pakistan, we found that contrary to the desired boost/stabilization in real growth, the policy (via. inflation bias) produced counterproductive results. Inflation bias was not merely ineffective in inducing real growth but significantly destabilized it. Moreover, the results, which are robust to different inflation bias indicators and subsample analysis, indicate that the higher the inflation bias, the higher is the intensity (magnitude) of its destabilizing effect and vice versa. This suggests that a policy that would minimize/constrain inflation bias would be a better choice as it would not only help achieve low and stable inflation but also a sustainable real economic growth.     

On the predictive power of the term structure of interest rates for future inflation changes in the presence of political instability: the Turkish economy

This study investigates whether the term structure contains useful information about future inflation for Turkey during 1990–2000, a period of high inflation, high budget deficits, and political instability. Constant parameter and time varying parameter models are rejected by the data. The relationship between term structure of interest rates and inflation changes is found to be explained by a time-varying-parameter model with Markov-switching heteroskedastic disturbances. Thus, the term structure of interest rates is limited as a guide for monetary policy in an economy subject to regime changes such as that of Turkey. Stability can be achieved only by reducing inflation through circumscribing substantial government budget deficits and the political instability underlying them.     

Sustainability of fiscal deficits, monetary policy, and inflation stabilization: The case of Turkey

There is a widespread consensus among economists that the goal of monetary policy, above all else, should be price stability. This study, by analyzing the Turkish experience in the last 15 years, emphasizes the importance of coordination of fiscal and monetary policies in achieving this aim. It is shown that, despite the rapidly changing financial environment, there are stationary long-run money-income relationships. Moreover, the growth rates of various monetary aggregates have predictive power for future movements in the consumer price index. However, as the Turkish experience made clear, in an economy where there are persistent budget deficits, these properties are not sufficient to conduct a successful monetary policy. The sustainability of fiscal policy is analyzed and rejected. Next, in a medium-term perspective, the levels of sustainable budget deficits compatible with a declining inflation path are calculated by making use of a small macroeconometric model.     

Interest rate policies and inflation in interdependent economies: Recent policy dilemmas

This paper examines Federal Reserve Board policies that are premised on a negative short-run association of interest rate movements and the rate of inflation. In particular, econometric evidence is provided, supporting the view that tighter monetary policy appears to raise inflation rates in the short run. Conversely, it is demonstrated that easier monetary policy does not necessarily raise inflation rates in the short run. In the case of uncoordinated monetary restrictiveness, interest rate competition among major countries can produce higher inflation and lower growth than was originally intended.     

Understanding the evolving inflation process in China: 1997–2011

This paper analyzes the evolving inflation process in China from 1997 to 2011. We construct a multivariate dynamic framework that captures the features of interactions between inflation and other relevant variables in China. Empirical results show that excess liquidity holds the most important predictive power on inflation in China. Further investigation demonstrates that there is significant pass-through effect from exchange rates and import prices to domestic inflation. We conclude with several significant policy implications that are drawn from our findings.     

Expectations and the inertia of inflation: The case of Indonesia

It has long been recognised that the balance between backward-looking and forward-looking expectations has critical policy implications. This is because backward-looking expectations impart a substantial degree of inertia to the inflation rate whereas forward-looking expectations lead to rapid adjustment in response to shocks. In this paper we examine the policy implications for the Indonesian economy of the form taken by the price adjustment equation. We allow for both backward-looking and forward-looking effects of inflation expectations, proxying forward expectations with the realised rate and using a GMM estimator to allow for the resulting endogeneity. Using monthly data from 1980:1 to 2008:12, our estimates show that CPI inflation in Indonesia is significantly determined by backward-looking inflation expectations, forward-looking inflation expectations, the output gap, exchange rate depreciation, and money growth. However, the backward expectation attracts a significantly higher weight than the forward rate leading to the conclusion that inflation in Indonesia has considerable inertia. The implication of this is that a gradualist monetary policy is likely to be more effective as a means of smoothing fluctuations in inflation and real output.     

Macroeconomic performance of inflation targeting in European and Asian emerging economies

The macroeconomic performance resulting from adopting an inflation targeting policy in emerging economies of Europe and Central Asia are examined. The research includes 26 countries in the period 1997–2019, with a special focus on the period 2008–2019. Our econometric analysis consists of two approaches: dynamic panel modeling and propensity score matching. The results suggest that macroeconomic performance has improved due to the inflation targeting monetary framework. We find that a policy of inflation targeting has been effective in reducing the inflation rate, inflation volatility, and GDP volatility. The results are particularly robust for the subperiod that started in 2008. Econometric results suggest that inflation targeting policy did not affect inflation persistence or GDP growth. Our results suggest that inflation targeting improves the macroeconomic performance of developing countries even when they only partially meet the standard requirements for its implementation.     

Wearing corset,losing shape: The euro's effect on trade imbalances

When does trade become a one-way relationship? We study bilateral trade balances for a sample of 18 European countries over the period from 1948 through 2008. We find that, with the introduction of the euro, trade imbalances among euro area members widened considerably, even after allowing for permanent asymmetries in trade competitiveness within pairs of countries or in the overall trade competitiveness of individual countries. This is consistent with indications that pair-wise trade tends to be more balanced when nominal exchange rates are flexible. Intra-euro area imbalances also seem to have become more persistent with the introduction of the euro, some of which is linked to labor market inflexibility. Reviewing the direction of imbalances, we find that bilateral trade surpluses are decreasing in the real exchange rate, decreasing in growth differentials, and increasing in the relative volatility of national business cycles. Finally, countries with relatively higher fiscal deficits and less flexible labor and product markets exhibit systematically lower trade surpluses than others.     

Commodities and monetary policy: Implications for inflation and price level targeting

We examine the relative ability of inflation targeting and price level targeting monetary policy rules to minimize inflation variability and business cycle fluctuations in a commodity-exporting country for supply and demand shocks to global commodity markets. The macroeconomic consequences of oil and non-oil primary commodities differ and affect the relative merits of the alternative monetary policy frameworks. Particularly, the consumption of refined oil products and demand-driven commodity price movements induce highly persistent inflation pressures resulting in a significant deterioration of the inflation-output gap trade-off available to central banks. When such terms-of-trade shocks are prevalent, price level targeting is inferior to inflation targeting.     

Trend inflation,the labor market wedge,and the non-vertical Phillips curve

Recent developments in macroeconomics resurrect the view that welfare costs of inflation arise because the latter acts as a tax on money balances. Empirical contributions show that wage re-negotiations take place while expiring contracts are still in place. Bringing these seemingly unrelated aspects together in a stylized general equilibrium model, we find a disciplining effect of a positive inflation target on the wage markup and identify a long-term trade-off between inflation and output. This has important policy implications, ranging from the opportunity of revising the target in response to shocks, to the possibility of exploiting inflation as a tool to increase tax revenues via its employment-enhancing effect.     

Are government deficits the prime cause of inflation?

We argue in this article that if government bonds are counted as part of private wealth, government budget deficits are a major cause of inflation, and the method chosen to finance the deficits (e.g., borrowing or monetary expansion) is of secondary importance. To illustrate this point we use a simple portfolio model that is then incorporated into a model of the Australian economy. The full model is specified in continuous time, and it is estimated by the full information maximum likelihood method (FIML) it is then used to simulate a number of fiscal shocks.     

Zero Lower Bound and negative interest rates: Choices for monetary policy in the UK

There have been relatively few analyses of the policy context and consequences of a Zero Lower Bound (ZLB) for nominal interest rates. This paper sets out monetary policy alternatives, including negative interest rates, a revision of the inflation target, and rendering unconventional policy instruments such as QE conventional (permanent). Following extensive discussion of policy options, we set out a model that explores the impacts of the real policy rate on economic growth, employment and inflation, with particular attention to the British economy. We use a Time-Varying Structural Vector Auto-regressive (TVSVAR) Model where the sources of time variation are both the coefficients and variance–covariance matrix of the innovations. It was found that real rates have significant implications for real growth, the labour market and price stability even when monetary policy was constrained at the ZLB in nominal terms. The study additionally applies a discrete break in the data to focus on the Post-Global Financial Crisis and ZLB period. This indicates that the effectiveness of real rates did not diminish and this has important implications in terms of a policy approach which seeks to exploit real negative rates.     

Does inflation targeting lower inflation and spur growth?

Over the last few decades several countries have turned to inflation targeting as a policy choice for instilling stability into their economies. Prior studies have shown that inflation targeting has reduced inflation in those countries without significantly impacting GDP. This study seeks to improve upon these results by identifying the impact of timing on the policy decision as well as its impact as related to specific regions of the world. The focus is on developing countries across six regions. We find significant regional variation in developing countries in our sample in terms of the direction of changes in inflation following a switch to the inflation targeting policy. Moreover, although the impact of inflation targeting on real GDP is minimal overall, there is a statistically significant increase in real GDP among developing countries in certain regions only, namely, Europe, Latin America, and the Middle East.     

Money and Swedish inflation

Analysing the role of money for Swedish inflation, we apply a single equation “P-Star” model and a structural VECM for the period of the late 1980s to the beginning of 2005. Against the background of theoretical and empirical considerations, we find that money – when measured by the “price gap” or, alternatively, the “money overhang” – had a statistically significant impact on future price movements. The results suggest that money might have to play a more prominent role in monetary policy making in Sweden compared with the status quo.     

On evaluating and extending the target zone proposal

This article examines the target zone proposal for exchange-rate management by presenting the results of simulations performed on both a large macroeconometric model and a small analytical model. The main conclusions derived from the large model are: (1) that exchange-rate-oriented monetary policy could have curbed misalignments without undermining counterinflation policy, but (2) a major impact on current balances would have required compensatory fiscal policy as well. The small model suggests the value of assigning world interest rates to the pursuit of a (flexible) world nominal income target and fiscal policy to national nominal income targets, if interest rate differentials are assigned to exchange-rate management.     

The trinity of wage setting in EMU: A policy proposal

Diverging labor cost developments are often considered to be one of the most important factors that led to large current account imbalances in the euro area (EA) in the run-up to the global financial crisis. It has also been shown that wage growth differentials have significantly lowered the co-movement of EA countries’ business cycles – the most widely used meta-criterion for optimum currency areas. Against this background, this paper develops a wage-setting benchmark that aims to keep the economy in internal equilibrium and to maintain price stability, while it also exhibits the capacity to correct for external imbalances. The proposed wage benchmark is very simple and may serve as an anchor for the macroeconomic dialogue in Economic and Monetary Union. In order to demonstrate the potentially beneficial effects of such a wage benchmark we present some simulations showing how current account balances and labor costs would have developed across EA countries if the rule had served as a benchmark already in the run up to the crisis.     

Preferences of the Central Bank of Brazil under the inflation targeting regime: Estimation using a DSGE model for a small open economy

The main objective of this paper is to estimate the preferences of the Central Bank of Brazil after the inflation targeting regime (January 2000 to December 2013), using a DSGE model with microeconomic foundations for a small open economy, based especially on the work of Kam et al. (2009). The model used in this study considers that the Central Bank minimizes a loss function, taking into account the deviation of inflation from its target, output stabilization, the interest rate smoothing and, unlike the previous works, the exchange rate. The results show that the major concern of the monetary authority in the period was the stabilization of inflation, followed by interest rate smoothing, exchange stabilization and, finally, output stabilization. The large value for the exchange rate smoothing parameter suggests the presence of fear of floating in the Brazilian case. An improved inflation targeting strategy should allow for less Central Bank intervention in the exchange rate market.     

The long-run impact of inflation in South Africa

This paper evaluates the hypothesis of long-run super-neutrality of money (LRSN) within the context of the South African economy. The long-run impact of inflation on the interest rate and subsequently, output is estimated by employing a trivariate structural vector autoregression model, using quarterly data for the period of 1960:1 to 2010:1. The estimation results suggest that the hypothesis of LRSN cannot be rejected, thereby suggesting that monetary policy in South Africa cannot be used to solve the large and persistent unemployment problem in South Africa, which is understandable, since unemployment is inherently structural and is due to skills-shortage. This is further supported by our one of our other results which shows that significant long-run impact on output is obtained from technological improvements.