animal spirits and credit cycles in this paper we extend the behavioral macroeconomic model as proposed by de grauwe 2012 to include a banking sector the behavioral model takes the view that agents have limited cognitive abilities as a result it is rational to use simple forecasting rules and to subject the use of these rules to a fitness test agents are then driven to select the rule that performs best the behavioral model produces endogenous and self fulfilling movements of optimism and pessimism animal spirits our main result is that the existence of banks intensifies these movements creating a greater scope for booms and busts thus banks do not create but amplify animal spirits we find that increases in the equity ratios of banks tend to reduce the importance of animal spirits over the business cycle the other policy conclusion we derive from our results is that the central bank has an important responsibility for stabilising output output stabilization is an instrument to tame the animal spirits this has the effect of improving the trade off between inflation and output volatility

inflation targeting what can the ecb learn from the recent experience of the bank of england establishment of the european central bank presents a rare opportunity to define the operations of a central bank without a prior track record this paper asks what might be learnt from the recent experience of inflation targeting at the bank of england before the ecb specifies an as yet undefined operational target we consider whether there should be single or multiple targets and which inflation measure should be used if at all if inflation is targeted then a forecast of its value becomes the intermediate variable this raises an issue of transparency and the compensating supply of information necessary to fill the gap but too much openness can also be problematic the ecb must be accountable and the contracting approach may be useful although being seen to say and do the same thing is ultimately most important opportunity presents itself to define the provisions for the structure and operation of a central bank without a prior historical track record some of these are already written into the statutes of the maastricht treaty which for example defines the ecb s primary statutory duty to be that of the pursuit of price stability and it has been the remit of the european monetary institute emi to make recommendations on other aspects critically however the terms of reference for the ecb in relation to an operational target for its monetary policy are yet to be resolved and although a statement from the ecb is expected to clarify the issue by september after this paper was finalised this need not be the end of the matter circumstances could well call for a subsequent recommendation the emi 1997 provisionally narrowed the choice to one between monetary targets and inflation targets since inflation targeting is the latest game in town it seems important to take stock of the experience of those newly independent central banks which have adopted it it is rather too soon to reach a definitive conclusion on the performance of inflation targeting central banks so what we consider are the lessons to be learnt from the mechanisms and structures that have been adopted by various inflation targeting central banks focusing in particular on the policies of the

why should central banks avoid the use of the underlying inflation indicator abstract this paper assesses the usefulness of the commonly used underlying inflation indicator in light of the criteria proposed in marques et al evaluating core inflation indicators mimeo 2001 empirical evidence for a group of six countries strongly suggests that the use of underlying inflation as an indicator of trend inflation should be avoided

inventory dynamics and business cycles what has changed to what extent can information technology led improvements in inventory management account for the apparent moderation of economic fluctuations in the united states since the mid 1980s we argue that changes in inventory dynamics played a reinforcing rather than a leading role in the reduction of output volatility since the mid 1980s inventory dynamics have changed in a manner consistent with a faster resolution of inventory imbalances however these changes appear to be a consequence of changes in the response of industry level sales and aggregate economic activity to monetary policy shocks our results suggest that it is the interaction between the changes in inventory behavior at the industry level and the macroeconomic environment where the latter likely includes changes in the conduct of monetary policy and the responses of the economy to policy disturbances rather than any single factor that has contributed importantly to the observed decline in economic volatility

the role of cognitive limitations and heterogeneous expectations for aggregate production and credit cycle abstract the behavioural model of de grauwe and macchiarelli 2015 is extended to include financial frictions on the aggregate supply side the result is a tight and sustained feedback loop between animal spirits on one hand and supply of credit capital purchase and production on the other during phases of optimism credit is abundant access to production capital is easy the cash in advance constraint is lax risks are undervalued and production is booming upon reversal in market sentiment the contraction is quick and deep moreover the model is capable of replicating the stylized fact of a long and sustained simultaneous growth in credit production and asset prices observed in the us since mid1990 s lastly the behavioural model does a decent job in matching us data including multiple supply side relations including capital firm credit and inflation interest rate

maintaining low inflation money interest rates and policy stance abstract this paper presents a systematic empirical relationship between money and subsequent prices and output using us euro area and swiss data since the 1960 1970s monetary developments unlike interest rate stance measures are shown to provide qualitative and quantitative information on subsequent inflation the usefulness of monetary analysis is contrasted to weaknesses in modeling monetary policy and inflation with respectively short term interest rates and real activity measures the analysis sheds light on the recent change in inflation volatility and persistence as well as on the phillips curve flattening and reveals drawbacks in pursuing a low inflation target without considering monetary aggregates

macroeconomic forecasting in the euro area country specific versus area wide information abstract this paper compares several time series methods for short run forecasting of euro wide inflation and real activity using data from 1982 to 1997 forecasts are constructed from univariate autoregressions vector autoregressions single equation models that include euro wide and us aggregates and large model methods in which forecasts are based on estimates of common dynamic factors aggregate euro wide forecasts are constructed from models that utilize only aggregate euro wide variables and by aggregating country specific models the results suggest that forecasts constructed by aggregating the country specific models are more accurate than forecasts constructed using the aggregate data

when are fixed exchange rates really fixed abstract this paper analyzes the sustainability of fixed exchange rates by extending the time inconsistency framework to a fully dynamic context in which the level of a state variable in this case debt determines the payoffs available to the government at each point in time the model yields the following results if debt is sufficiently low there is an equilibrium in which the government does not devalue for an intermediate range of debt levels the government devalues in response to an attack but not otherwise so that self fulfilling attacks can occur finally for yet another debt range there can also be sunspot equilibria in which an attack and the corresponding devaluation occurs with positive probability

real time density forecasts from bayesian vector autoregressions with stochastic volatility central banks and other forecasters are increasingly interested in various aspects of density forecasts however recent sharp changes in macroeconomic volatility including the great moderation and the more recent sharp rise in volatility associated with increased variation in energy prices and the deep global recession pose significant challenges to density forecasting accordingly this paper examines with real time data density forecasts of u s gdp growth unemployment inflation and the federal funds rate from bayesian vector autoregression bvar models with stochastic volatility the results indicate that adding stochastic volatility to bvars materially improves the real time accuracy of density forecasts this article has supplementary material online

do core inflation measures help forecast inflation abstract we conduct cointegration and granger causality tests for traditional and new measures of core inflation we find that both measures are consistent with desired properties of measures of underlying inflation but neither is very useful for forecasting purposes

the two pillars of the european central bank i interpret the european central bank s two pillar strategy by proposing an empirical model for inflation that distinguishes between the short and long run components of inflation the latter component depends on an exponentially weighted moving average of past monetary growth and the former on the output gap estimates for the 1971 2003 period suggest that money can be combined with other indicators to form the broadly based assessment of the outlook for future price developments that constitutes the ecb s second pillar however the analysis does not suggest that money should be treated differently from other indicators while money is a useful policy indicator all relevant indicators should be assessed in an integrated manner and a separate pillar focused on monetary aggregates does not appear necessary stefan gerlach

the forecasting power of real interest rate gaps an assessment for the euro area the real interest rate gap irg the gap between the short term real interest rate and its natural level is a theoretical concept that has attracted much attention in central banks in recent years this article aims at clarifying its practical relevance for monetary policy in real time for this purpose it provides an empirical assessment of the usefulness of a semi structural versus purely statistical estimates of the real irg for predicting policy relevant macroeconomic variables in the euro area however mixed the results confirm that semi structural estimates of the real irg deserve being added to the central banks toolbox

tracking real time data revisions in inflation persistence abstractregarding the forecasting of real time data it is assumed that the third quarter release produces the best forecasts since it includes data from new and revised sources which this paper f

interpreting euro area inflation at high and low frequencies abstract several authors have recently interpreted the european central bank s ecb s two pillar framework as separate approaches to forecast and analyse inflation at different time horizons or frequency bands the ecb has publicly supported this understanding of the framework this paper presents further evidence on the behaviour of euro area inflation using band spectrum regressions which allow for a natural definition of the short and long run in terms of specific frequency bands and causality tests in the frequency domain the main finding is that variations in inflation are well explained by low frequency movements of money and real output growth and high frequency fluctuations of the output gap

commodity trade and international risk sharing how much do financial markets matter abstract this paper evaluates the social gains from international risk sharing in some simple general equilibrium models with output uncertainty a simulation model calibrated to selected moments of u s and japanese data estimates the incremental loss from a ban on international portfolio diversification to be on the order of 0 20 percent of output per year even the theoretical gains from asset trade may disappear under alternative sets of assumptions on preferences and technology the paper argues that the small magnitude of potential trade gains may help explain the apparently inconsistent findings of empirical studies on the degree of international capital mobility

a combined measure of uk core inflation estimates this article estimates uk core inflation in a structural vector autoregression var framework while building on the work of quah and vahey 1995 we extend their two variable var model to allow for different dynamics depending on the nature of the shocks that potentially influence the process of core inflation we also construct a combined measure of core inflation estimates on the basis of their reliabilities empirical evidence shows that the new measures demonstrate marked improvement in their eligibility to serve as core inflation estimators furthermore the combined measure is shown to perform best it appears that the conventional core measures such as the retail prices excluding mortgage interest payments rpix and the harmonized index of consumer prices hicp inflation series are not successful in capturing the underlying trend of inflation casting some doubt on their current use in the making of monetary policy decisions

time consistent fiscal policy and government cash flow abstract this short paper provides an interpretation and some extensions of lucas and stokey s results on optimal fiscal policy the discussion relies heavily on the concept of government cash flow which is related but not equal to the budget surplus time consistency of the optimal policy requires that a positive cash flow is used to buy up some debt of each maturity and contingency

a new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the business cycle abstract this paper introduces a general procedure for decomposition of non stationary time series into a permanent and transitory component allowing both components to be stochastic the permanent component is shown to be a random walk with drift and the transitory or cyclical component is a stationary process with mean zero the decomposition methodology which depends only on past data and therefore is computable in real time is applied to the problem of measuring and dating business cycles in the portwar u s economy we find that measured expansions and contractions are of roughly equivalent duration and that our dating of cyclical episodes tends to lead the traditional nber dating and to a lesser extent the growth cycle chronology of zarnowitz and boschan 1977

loss aversion and the asymmetric transmission of monetary policy there is widespread evidence that monetary policy exerts asymmetric effects on output over contractions and expansions in economic activity while price responses display no sizeable asymmetry to rationalize these facts we develop a dynamic general equilibrium model where households utility depends on consumption deviations from a reference level below which loss aversion is displayed state dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption generate competing effects on output and inflation contractions face the central bank with higher responsiveness of output to interest rate changes as well as a flatter aggregate supply schedule

inflation measurement and the ecb s pursuit of price stability a first assessment as part of its monetary policy strategy announced in 1998 the ecb provided a quantitative definition of its price stability objective as an annual rate of increase in the harmonized index of consumer prices hicp of below 2 0 percent this paper takes a measurement perspective in evaluating the ecb s quest for price stability during the first years of monetary we consider the following questions first what is the hicp designed to measure and how accurate is it in terms of its stated objective second how accurate are the traditional exclusion type measures of core inflation derived from the hicp and more importantly is there evidence that less traditional measures of core inflation might be useful to the ecb and third is there any sense in which the ecb s definition of price stability in terms of a 2 0 percent limit on hicp inflation can be said to be too low from a measurement perspective we conclude that the conceptual underpinnings of the hicp remain sufficiently vague that it is difficult to compare with other indexes or come to any hard conclusions about its accuracy it is possible that the hicp is as susceptible to the biases that are known to affect other measures of inflation at the consumer or household level and if forced to quantify potential bias a point estimate of 1 0 percent strikes us as reasonable potential bias of this magnitude in conjunction with the inherent noisiness of the headline number and the well known aversion of central bankers to deflation argues for a modest upward redefinition of the rate of hicp inflation consistent with price stability finally we show that the ecb would be well served by increasing their use of nontraditional core inflation measures

sustainable plans and mutual default this paper presents a simple general equilibrium model of optimal taxation in which both private agents and the government can default on their debt as a benchmark we consider ramsey equilibria in which the government can precommit to its policies at the beginning of time but in which private agents can default we then consider sustainable equilibria in which both government and private agent decision rules are required to be sequentially rational we adapt abreu s 1988 optimal trigger strategies to completely characterize the entire set of sustainable equilibria in particular we show that when there is sufficiently little discounting and government consumption fluctuates enough the ramsey allocations and policies in which the government never defaults can be supported by a sustainable equilibrium by way of an example we show that the larger the variance of government consumption the easier it is to support good outcomes we also show for moderate discount factors that in the best sustainable equilibrium tax rates are more volatile and debt is smaller than in the ramsey equilibrium

inflation forecast targeting implementing and monitoring inflation targets abstract inflation targeting is shown to imply inflation forecast targeting the central bank s inflation forecast becomes an explicit intermediate target inflation forecast targeting simplifies both implementation and monitoring of monetary policy the weight on output stabilization determines how quickly the inflation forecast is adjusted towards the inflation target money growth or exchange rate targeting is generally inferior than inflation targeting and leads to higher inflation variability commitment to target rules may be better than commitment to instrument rules

permanent transitory decompositions and traditional measures of core inflation abstract the aim of this paper is twofold first after defining core inflation in line with the recent literature as the long run component of the rate of change of the consumer price index cpi we address the general problem of establishing a set of conditions under which given the assumption of inflation as an i 1 process it is possible to identify an indicator of trend inflation we show that some criteria recently proposed in the literature economics letters 75 2002 17 are unnecessarily restrictive second an empirical investigation for the period 1983 2001 reveals that these conditions are met in the us economy both for the traditional measure of core inflation which is obtained by subtracting food and energy components from cpi and for the weighted median of cpi proposed by monetary policy university of chicago press for nber 1994 261 these conclusions hold for a measure of core inflation based on the year on year rate of change of the core index and thus we provide some motivation for this choice

time consistency of fiscal and monetary policy a comment in an important recent contribution persson persson and svensson 1987 hereafter pps suggest that through careful restructuring of its nominal and real debt obligations a government may be able to induce future governments to follow the monetary and fiscal policies that it regards as optimal today the pps argument builds on lucas and stokey s 1983 demonstration that in a special nonmonetary setting the time inconsistency of optimal fiscal policy can be avoided through managing the term structure of real government obligations to the public the basic idea of the pps scheme for monetary economies is disarmingly intuitive in addition to continually restructuring nominal and real debt obligations a la lucas stokey each government must ensure that the next government inherits a stream of nominal claims on the public whose present discounted value equals the stock of money this equality pps argue removes the incentive for surprise inflation or deflation because such surprises would not affect the real net worth of the government this note shows that the pps prescription for avoiding time inconsistency appealing as it is is not generally sufficient even under the debt restructuring they recommend optimal policy is likely to be time inconsistent the main reason why their scheme fails is that the restrictions it imposes on government asset stocks satisfy first order but not second order conditions for an optimum because of the complex interactions between the current price level and future interest rates a government can raise its objective function by moving several variables at once away from the levels planned by the previous government even though price level changes alone would not affect government net worth we develop our argument using the model notation and equation numbers of pps to which the reader is referred for details the maximization problem associated with

core inflation and trend inflation abstract this paper examines empirically whether the measurement of trend inflation can be improved by using disaggregated data on sectoral inflation to construct indexes akin to core inflation but with a time varying distributed lags of weights where the sectoral weight depends on the timevarying volatility and persistence of the sectoral inflation series and on the comovement among sectors the modeling framework is a dynamic factor model with time varying coefficients and stochastic volatility as in del negro and otrok 2008 and is estimated using u s data on seventeen components of the personal consumption expenditure inflation index

a simple adaptive measure of core inflation this paper proposes a new measure of core inflation and compares it with several existing measures the new measure is adaptive and is designed to track sudden and persistent movements in inflation such as those arising from changes in monetary policy regimes the adaptive measure filters out transients more effectively than existing measures and it is a superior predictor of locally mean reverting components of inflation

global behaviour of a system with imperfect private public substitutability abstract empirical findings reveal that the relationship between private and public consumption generically differs from country to country it is substitutable for some while it is complementary for others the present paper incorporates this regularity into a simple growth model with public goods which affect utility and production the model casts off the standard assumption of socially constant returns to scale and as a result it generates many interesting dynamic features which do not arise with constant returns when the system displays increasing returns the dynamic path may diverge from an interior equilibrium in expanding oscillations suggesting that self fulfilling expectations could play an essential role with decreasing returns the interior equilibrium becomes a saddle point interestingly it turns out that the substitutability versus complementarity distinction does make a difference in affecting the stationary state and its transitional dynamics

time consistent control in non linear models abstract the paper shows how to use optimal control to compute optimal time consistent markovian government policies in nonlinear dynamic general equilibrium models it extends cohen and michel s 1988 results for the linear quadratic case the method involves replacing private agents costate variables with flexible functions of current state variables in the government s maximization problem the functions hold in equilibrium to an arbitrarily close approximation they can be found numerically by perturbation or projection methods a stochastic model of optimal public spending illustrates the technique

optimal fiscal and monetary policy in an economy without capital abstract this paper is concerned with the structure and time consistency of optimal fiscal and monetary policy in an economy without capital in a dynamic context optimal taxation means distributing tax distortions over time in a welfare maximizing way for a barter economy our main finding is that with debt commitments of sufficiently rich maturity structure an optimal policy if one exists is time consistent in a monetary economy the idea of optimal taxation must be broadened to include an inflation tax and we find that time consistency does not carry over an optimal inflation tax requires commitment by rules in a sense that has no counterpart in the dynamic theory of ordinary excise taxes the reason time consistency fails in a monetary economy is that nominal assets should from a welfare maximizing point of view always be taxed away via an immediate inflation in a kind of capital levy this emerges as a new possibility when money is introduced into an economy without capital

survey measures of expected inflation and the inflation process the accuracy of inflation forecasts obtained from household and professional surveys has deteriorated noticeably of late to the extent that a simple autoregressive specification outperforms survey forecasts the decline in absolute and relative accuracy has taken place at about the same time as an apparent change in the inflation process projections of household forecasts on realized inflation suggests that households have not recognized this change for the professionals projections of expected inflation on headline inflation have changed but on core inflation have not by contrast projections of realized headline inflation on core have changed sharply

do underlying measures of inflation outperform headline rates evidence from australian data many central banks often focus on underlying measures of inflation when assessing inflation trends this paper compares the accuracy of underlying measures of inflation relative to the headline rates by using australia data it is found that the underlying measures did have smaller errors in predicting the long term trend in inflation than the quarterly headline rate due to the volatility in the headline rate as compared to the year ended headline rate the statistical test results however support only the measure of market prices excluding volatile items not the others there is some weak evidence of the weighted median measure outperforming the headline rate in the sub period after 1993 with respect to directional accuracy the test statistics cannot reject the null hypothesis of an equal probability correctly predicting the moving direction of the inflation trend though the headline rates have a higher probability

estimating potential output core inflation and the nairu as latent variables this article proposes a new method to obtain estimates of the nairu the core inflation rate and the trend investment rate for the united states using an unobserved components model that is compatible with the usual decomposition of real gross domestic product into trend and cycle the model includes okun s law a forward looking phillips curve and an accelerator type investment equation and accounts for some volatility breaks in two components the unknown parameters in the model are estimated by maximum likelihood using a kalman filter initialized with a partially diffuse prior and the unobserved components are estimated using a smoothing algorithm our results show that the output gap is positively correlated with the deviations of the investment rate from its trend and the inflation rate from core inflation and negatively correlated with the deviations of the unemployment rate from the nairu

do core inflation measures help forecast inflation out of sample evidence from french data abstract this paper compares the ability of four indicators of underlying or core inflation to forecast inflation in the french case though most indicators granger cause inflation results from out of sample tests of forecast accuracy are less compelling the results nevertheless seem to give some empirical support to trimmed mean indicators

a core inflation indicator for the euro area this paper proposes a new core inflation indicator for the euro area obtained by cleaning monthly price changes from short run volatility idiosyncratic and measurement errors we use a factor model to project monthly inflation on a large panel of time series exploiting multivariate information we obtain a satisfactory degree of smoothing without using backward looking moving averages which induce a time delay in the signal the indicator forecasts inflation and is a useful tool for policy makers it outperforms other commonly used predictors at 6 months and longer horizons it tracks past policy interventions of the ecb

examining the ability of core inflation to capture the overall trend of total inflation this article examines whether core inflation is able to predict the overall trend of total inflation using real time data in a parametric and nonparametric framework specifically two sample periods and five in sample forecast horizons in two measures of inflation which are the personal consumption expenditure pce and the consumer price index cpi are used in the exclusions from core inflation persistence model this article finds that core inflation is only able to capture the overall trend of total inflation for the 12 quarter in sample forecast horizon using the cpi in both the parametric and nonparametric models in the longer sample period the nonparametric model outperforms the parametric model for both data samples and for all five in sample forecast horizons

time consistency of fiscal and monetary policy the problem of time inconsistency arises from two different sources first as shown by guillermo a calvo 1978 the re is an incentive for each government to engage in an initial unanti cipated inflation second as discussed by robert e lucas and nancy l stokey 1983 there is an incentive for each government to deviat e from the path of taxes announced by the preceding government in th is paper it is shown that these two sources of time inconsistency ca n be removed by a particular method of debt management involving bot h nominal and indexed government bonds of various maturities copyright 1987 by the econometric society

relative price changes as aggregate supply shocks this paper proposes a theory of supply shocks or shifts in the short run phillips curve based on relative price changes and frictions in nominal price adjustment when price adjustment is costly firms adjust to large shocks but not to small shocks and so large shocks have disproportionate effects on the price level therefore aggregate inflation depends on the distribution of relative price changes inflation rises when the distribution is skewed to the right and falls when the distribution is skewed to the left we show that this theoretical result explains a large fraction of movements in postwar u s inflation moreover our model suggests measures of supply shocks that perform better than traditional measures such as the relative prices of food and energy

does the time consistency problem explain the behavior of inflation in the united states abstract this paper derives the restrictions imposed by barro and gordon s theory of time consistent monetary policy on a bivariate time series model for inflation and unemployment and tests those restrictions using quarterly us data from 1960 through 1997 the results show that the data are consistent with the implications of the theory for the long run behavior of the two variables indicating that the theory can explain the initial rise and subsequent fall of inflation over the past four decades the results also suggest that the theory must be extended to account more fully for the short run dynamics that appear in the data

on the asymmetric u shaped relationship between inflation inflation uncertainty and relative price skewness in the uk we investigate the asymmetric relationships between aggregate inflation and the second and third moments of the cross sectional distribution of relative prices using a modified calvo pricing model with regime dependent price rigidities calibration experiments reveal that the inflation standard deviation and inflation skewness relationships exhibit u shaped asymmetries around the historical mean inflation rate uk sectoral data support our results we conclude that monetary policy should target an inflation rate proximate to the common minima of these nonlinear relationships and that core inflation measures should not be used for policy purposes as they exclude much of the information contained in the higher moments

core measures of inflation as predictors of total inflation two rationales offered for policymakers focus on core measures of inflation as a guide to underlying inflation are that core inflation omits food and energy prices which are thought to be more volatile than other components and that core inflation is thought to be a better predictor of total inflation over time horizons of import to policymakers our investigation finds little support for either rationale we find that food and energy prices are not the most volatile components of inflation and that depending on which inflation measure is used core inflation is not necessarily the best predictor of total inflation however we do find that combining cpi and pce inflation measures can lead to statistically significant more accurate forecasts of each inflation measure suggesting that each measure includes independent information that can be exploited to yield better forecasts

forecasting core inflation the case of south africa forecasting and estimating core inflation has recently gained attention especially for inflation targeting countries following research showing that targeting headline inflation may not be optimal a central bank can miss the signal due to the noise despite its importance there is sparse literature on estimating and forecasting core inflation in south africa with the focus still on measuring core inflation this paper emphasises predicting core inflation using large time varying parameter vector autoregressive models tvp vars factor augmented var and structural break models using quarterly data from 1981q1 to 2013q4 we use mean squared forecast errors msfe and predictive likelihoods to evaluate the forecasts in general we find that i small tvp vars consistently outperform all other models ii models where the errors are heteroscedastic do better than models with homoscedastic errors iii models assuming that the forgetting factor remains 0 99 throughout the forecast period outperforms models that allow for the forgetting factors to change with time and iv allowing for structural break does not improve the predictability of core inflation overall our results imply that additional information on the growth rate of the economy and interest rate is sufficient to forecast core inflation accurately but the relationship between these three variables needs to be modelled in a time varying nonlinear fashion

a simple inflation indicator for the euro zone this article proposes and estimates an inflation indicator for the european monetary union emu this indicator is set up so that it is contemporarily not affected by the changes in price differentials among emu countries the results show that the monetary union index of consumer prices muicp which is the inflation measure that the european central bank ecb takes as a reference for monetary policy purposes could be understating the value of the inflation in the euro zone it is also concluded that regional peculiarities are fundamental in the evolution of prices in the different emu countries

measuring core inflation in this paper we argue that measured rpi inflation is conceptually mismatched with core inflation the difference is more than just measurement error we propose a technique for measuring core inflation based on an explicit long run economic hypothesis core inflation is defined as that component of measured inflation that has no medium to long run impact on real output a notion that is consistent with the vertical long run phillips curve interpretation of the co movement in inflation and output we construct a measure of core inflation by placing dynamic restrictions on a vector autoregression var system

inflation targeting and core inflation this paper examines the interaction of core inflation and inflation targeting as a monetary policy regime interest in core inflation has grown because of inflation targeting core inflation is defined in numerous ways giving rise to many potential measures this paper defines core inflation as the best forecaster of inflation a cross country study finds before the start of inflation targeting but not after core inflation differs between non inflation targeters and inflation targeters through conditional regressions inflation expectations as measured by core inflation have not changed with the advent of inflation targeting nor do they differ from non targeters jel classification e52 and e31 cible de maitrise de l inflation et inflation sous jacente ce texte examine l interaction entre l inflation sous jacente et l utilisation de cibles de maitrise de l inflation dans un regime de politique monetaire l interet pour l inflation sous jacente a crua proportion que l utilisation de cibles a cru l inflation sous jacente est definie de bien des manieres et se prete a plusieurs mesures potentielles ce texte la definit comme le meilleur predicteur de l inflation une etude transversale de plusieurs pays revele que l inflation sous jacente differe entre les pays qui ont des cibles et ceux qui n en n ont pas avant qu on commence a cibler mais pas apres via des regressions conditionnelles on montre que les anticipations d inflation telles que mesurees par l inflation sous jacente n ont pas change avec l arrivee du ciblage et qu elles ne different pas de celles des pays qui ne ciblent pas

european inflation dynamics abstract we provide evidence on the fit of the new phillips curve npc for the euro area over the period 1970 1998 and use it as a tool to compare the characteristics of european inflation dynamics with those observed in the u s we also analyze the factors underlying inflation inertia by examining the cyclical behavior of marginal costs as well as that of its two main components namely labor productivity and real wages some of the findings can be summarized as follows a the npc fits euro area data very well possibly better than u s data b the degree of price stickiness implied by the estimates is substantial but in line with survey evidence and u s estimates c inflation dynamics in the euro area appear to have a stronger forward looking component i e less inertia than in the u s d labor market frictions as manifested in the behavior of the wage markup appear to have played a key role in shaping the behavior of marginal costs and consequently inflation in europe

slack and cyclically sensitive inflation we investigate the flattening phillips relation by making two departures from standard specifications first we measure slack using real activity variables that are bandpass filtered or year over year changes in activity these are similar instead of gaps second we study the components of inflation instead of the standard aggregates we find that some inflation components have strong and stable correlations with the cyclical component of real activity these components tend to be relatively well measured and domestically determined other components typically prices that are poorly measured or internationally determined have weak and or unstable correlations with cyclical activity we construct a new inflation index cyclically sensitive inflation that weights the components by their joint cyclical covariation with real activity the index has strong and stable correlations with cyclical activity and provides a real time measure of cyclical movements in inflation

optimal taxation of capital income in general equilibrium with infinite lives this paper analyzes the optimal tax on capital income in general equilibrium models of the second best agents have infinite lives and utility functions which are extensions from the koopmans form the population is heterogeneous the important property of the models is the equality between the social and the private discount rates in the long run i find that the optimal tax rate is zero in the long run for a special case of additively separable utility functions i then determine the tax rates along the dynamic path and conditions that are sufficient for the local stability of the steady state

weighted median inflation is this core inflation this paper investigates core inflation defined as the best predictor of inflation i compare forecasts obtained using the mean weighted median trimmed mean and less food and energy inflation rates for the consumer price index and the personal consumption expenditure deflator for the current u s monetary policy regime another issue addressed is that of the systematic bias that exists due to the differences in means of these measures i test whether correcting for this bias can lead to better inflation forecasts this paper finds that adjusting for bias improves forecasting and that the weighted median is a better forecaster than the alternative measures and thus is a good measure of core inflation

diversification through trade a widely held view is that openness to international trade leads to higher income volatility as trade increases specialization and hence exposure to sector specific shocks contrary to this common wisdom we argue that when country wide shocks are important openness to international trade can lower income volatility by reducing exposure to domestic shocks and allowing countries to diversify the sources of demand and supply across countries using a quantitative model of trade we assess the importance of the two mechanisms sectoral specialization and cross country diversification and show that in recent decades international trade has reduced economic volatility for most countries

optimal monetary policy under low trend inflation abstract in the monetary policy literature it is common to assume that trend inflation is zero despite overwhelming evidence that zero inflation is neither empirically relevant nor a practical objective for central bank policy we therefore extend the standard new keynesian model to allow for positive trend inflation showing that even low trend inflation has strong effects on optimal monetary policy and the dynamics of inflation output and interest rates under discretion the efficient policy deteriorates and there is no guarantee of determinacy even with commitment targeting non zero trend inflation leads to substantial welfare losses our results serve as a warning against indiscriminate use of models assuming zero trend inflation

the specific factors continuum model with implications for globalization and income risk abstract this paper embeds the specific factors model in the goods continuum approach of dornbusch et al 1977 1980 and applies it to analyze the effect of globalization on income risk globalization amplifies sector specific income risk induced by idiosyncratic sectoral technology shocks but tends to reduce income risk to both mobile and immobile factors induced by aggregate technology shocks that differ by country aggregate risk bears most heavily on the poorest specific factors

on the optimal and best sustainable taxes in an open economy abstract we study a representative agent open economy in which government provided services that enter the domestic production function must be financed with distortionary taxes and focus on the optimal size of government and the associated optimal tax rate if the government can precommit its actions it maximizes individual welfare by announcing and implementing a constant tax rate which we refer to as the first best tax rate this tax rate is time inconsistent and under discretion the government implements a tax that maximizes each period s output which may be higher or lower than the first best rate depending on whether the elasticity of substitution in production between private and public inputs is below or above one in this paper we characterize the best sequence of tax rates that can be sustained through trigger strategies this best sustainable sequence of tax rates is constant and lies between the first best and discretionary extremes

combining var and dsge forecast densities a popular macroeconomic forecasting strategy utilizes many models to hedge against instabilities of unknown timing see among others stock and watson 2004 clark and mccracken 2010 and jore et al 2010 existing studies of this forecasting strategy exclude dynamic stochastic general equilibrium dsge models despite the widespread use of these models by monetary policymakers in this paper we use the linear opinion pool to combine inflation forecast densities from many vector autoregressions vars and a policymaking dsge model the dsge receives a substantial weight in the pool at short horizons provided the var components exclude structural breaks in this case the inflation forecast densities exhibit calibration failure allowing for structural breaks in the vars reduces the weight on the dsge considerably but produces well calibrated forecast densities for inflation

optimal redistributive capital taxation in a neoclassical growth model abstract this paper provides a counterexample to the simplest version of the redistribution models considered by judd 1985 in which the government chooses an optimal distortionary tax on capitalists to finance a lump sum payment to workers i show that the steady state optimal tax on capital income is generally non zero when the capitalists utility is logarithmic and the government faces a balanced budget constraint with log utility agents optimal decisions depend solely on the current rate of return not any future rates of return or tax rates this feature of the economy effectively deprives the government of a useful policy instrument because promises about future tax rates can no longer influence current allocations when combined with a lack of other suitable policy instruments such as government bonds the result is an inability to decentralize the allocations that are consistent with a zero limiting capital tax i show that the standard approach to solving the dynamic optimal tax problem yields the wrong answer in this knife edge case because it fails to properly enforce the constraints associated with the competitive equilibrium specifically the standard approach lets in an additional policy instrument through the back door

inflation and monetary dynamics in the us a quantity theory approach in this article we investigate the long run link between inflation and money growth in the united states since 1960 a measure of the long run inflation trend is constructed which bears the interpreation of monetary inflation rate and is directly related to the excess nominal money growth process money growth less output growth as postulated by the quantity theory consistent with the memory characteristics of the series their fractional integration and cointegration properties are taken into account in empirical modelling the proposed measure is then compared with several existing measures of core inflation aimed at capturing long run inflation dynamics but unrelated to money growth the monetary long run inflation rate performs well in out of sample forecasting exercises especially over a 2 3 year horizon yielding valuable information to monetary policymakers

short term interest rates as predictors of inflation on testing the hypothesis that the real rate of interest is constant in an innovative and provocative paper in this review eugene fama presents evidence which appears to be consistent with the joint hypothesis that the real rate of interest ignoring taxes is a constant and that the market for u s treasury bills is efficient in the sense of embodying rational expectations those findings are strikingly at variance with a long list of previous studies which seemed to support the view that the real rate of interest varies over time and can be related to economic variables such as real output monetary policy and so forth 2 the methodologies which lead to these contradictory conclusions are quite different previous studies had followed the lead of irving fisher by relating nominal interest rates to distributed lags on past rates of inflation 3 these distributed lags are generally interpreted as approximations to the market s expected rate of inflation and thus any remaining variation is attributed to variation in the real rate 4 fama s methodology on the other hand draws on the fact that the difference between the market interest rate and the subsequently observed rate of inflation the ex post real interest rate consists by definition of the ex ante real interest rate plus a pure forecasting error 5 the hypothesis of market efficiency implies that these forecasting errors must be serially random thus observing ex post real rates is equivalent to observing ex ante real rates with random measurement error these errors of course confound the problem of identifying variation in the ex ante real rate in this paper we will argue that the relative magnitude of these measurement errors is such that the tests carried out by fama were not powerful enough to reject the joint hypothesis that the ex ante real rate is a constant and expectations are rational more powerful tests which are presented in this paper using the same data do lead to rejection of that hypothesis of course rejection

tariffs as insurance optimal commercial policy when domestic markets are incomplete free trade is not optimal for a small country that faces uncertain terms of trade if some factors are immobile ex post and markets for contingent claims are incomplete the government can improve social welfare by using commercial policy that serves as a partial substitute for missing insurance markets using a combination of analytical and simulation techniques we demonstrate that optimal policy for this purpose will often have an anti trade bias we also show that the usual preference by economists for factor or product taxes and subsidies over tariffs and export subsidies may not be justified in this context this abstract was borrowed from another version of this item