Podcast
Questions and Answers
Shifts in the LM curve, driven by changes in money supply not related to output or real interest rates, always lead to movements along a fixed AD curve.
Shifts in the LM curve, driven by changes in money supply not related to output or real interest rates, always lead to movements along a fixed AD curve.
False (B)
DSGE models commonly assume that central banks directly control the money base rather than setting short-run interest rates.
DSGE models commonly assume that central banks directly control the money base rather than setting short-run interest rates.
False (B)
The primary objective of monetary policy in most countries is consistently focused on achieving full employment rather than price stability.
The primary objective of monetary policy in most countries is consistently focused on achieving full employment rather than price stability.
False (B)
Paul Volcker defined reasonable price stability as a situation where expectations of price changes have a significant influence on economic and financial behavior.
Paul Volcker defined reasonable price stability as a situation where expectations of price changes have a significant influence on economic and financial behavior.
According to Elderson (2021), the ECB considers climate change considerations a primary objective, superseding traditional economic goals.
According to Elderson (2021), the ECB considers climate change considerations a primary objective, superseding traditional economic goals.
In the long run, there generally exists a significant and exploitable trade-off between inflation and unemployment, enabling policymakers to optimize both.
In the long run, there generally exists a significant and exploitable trade-off between inflation and unemployment, enabling policymakers to optimize both.
A central bank with a hierarchical mandate is equally concerned with maximum employment and price stability.
A central bank with a hierarchical mandate is equally concerned with maximum employment and price stability.
The Treaty on the Functioning of the European Union imposes a dual mandate on the ECB which means they should pursue other economic goals simultaneously with price stability.
The Treaty on the Functioning of the European Union imposes a dual mandate on the ECB which means they should pursue other economic goals simultaneously with price stability.
The Federal Reserve operates under a clear hierarchical mandate, giving primacy to price stability over employment and long-term interest rates.
The Federal Reserve operates under a clear hierarchical mandate, giving primacy to price stability over employment and long-term interest rates.
A hierarchical mandate toward price stability definitively implies that inflation will always be kept constant in the short run, irrespective of output fluctuations.
A hierarchical mandate toward price stability definitively implies that inflation will always be kept constant in the short run, irrespective of output fluctuations.
The HICP primarily covers costs related to the purchase of dwellings and imputed rents for owner-occupied housing.
The HICP primarily covers costs related to the purchase of dwellings and imputed rents for owner-occupied housing.
Reliance on headline inflation offers a robust representation of persistent inflation trends due to its insulation from sector-specific short-run fluctuations.
Reliance on headline inflation offers a robust representation of persistent inflation trends due to its insulation from sector-specific short-run fluctuations.
In the context of monetary policy, 'one-off' changes in the price level typically warrant corrective action to maintain stability.
In the context of monetary policy, 'one-off' changes in the price level typically warrant corrective action to maintain stability.
Core inflation measures ensure better communication to the public because they will always capture the evolution of consumption prices experienced by domestic economic agents.
Core inflation measures ensure better communication to the public because they will always capture the evolution of consumption prices experienced by domestic economic agents.
Filtering according to the cross-section dimension aims to distill the component of headline inflation expected to endure over the long-term.
Filtering according to the cross-section dimension aims to distill the component of headline inflation expected to endure over the long-term.
The Implicit Price Deflator includes some items on a temporary basis.
The Implicit Price Deflator includes some items on a temporary basis.
The PCCI at the ECB averages the temporal component for the HICP.
The PCCI at the ECB averages the temporal component for the HICP.
Using a measure of core inflation makes the resulting measure more relevant to consumers.
Using a measure of core inflation makes the resulting measure more relevant to consumers.
The relative effectiveness of a point target versus a target range primarily hinges on the central bank's communication policy.
The relative effectiveness of a point target versus a target range primarily hinges on the central bank's communication policy.
Target ranges offer better signaling of certainty to markets which enhances policy efficacy.
Target ranges offer better signaling of certainty to markets which enhances policy efficacy.
A symmetric tolerance band around an inflation target is considered beneficial because it may lead to an upward or downward bias in inflation expectations.
A symmetric tolerance band around an inflation target is considered beneficial because it may lead to an upward or downward bias in inflation expectations.
Price-level targeting aims to maintain a constant rate of inflation, with bygones being bygones.
Price-level targeting aims to maintain a constant rate of inflation, with bygones being bygones.
Under price-level targeting, past forecasting errors are systematically ignored, influencing policy decisions for purely short-term gains.
Under price-level targeting, past forecasting errors are systematically ignored, influencing policy decisions for purely short-term gains.
The success of price-level targeting is conditional since it depends on credible effects on inflation expectations.
The success of price-level targeting is conditional since it depends on credible effects on inflation expectations.
Average inflation targeting, adopted by the Fed in 2020, eliminates history dependence, focusing solely on future inflation expectations.
Average inflation targeting, adopted by the Fed in 2020, eliminates history dependence, focusing solely on future inflation expectations.
Inflation can be accurately defined as any sustained one-off increase in the price of a critical commodity.
Inflation can be accurately defined as any sustained one-off increase in the price of a critical commodity.
Monetary neutrality assumes that changes in the money stock have no long-term effects on real variables like output.
Monetary neutrality assumes that changes in the money stock have no long-term effects on real variables like output.
The monetarist proposition, 'inflation is always and everywhere a monetary phenomenon,' is undisputed and empirically verified across all countries and time horizons.
The monetarist proposition, 'inflation is always and everywhere a monetary phenomenon,' is undisputed and empirically verified across all countries and time horizons.
In cost-push inflation, an upward shift of the aggregate supply (AS) curve for a given aggregate demand (AD) curve is typical.
In cost-push inflation, an upward shift of the aggregate supply (AS) curve for a given aggregate demand (AD) curve is typical.
Demand-pull shocks can lead to the persistent increasing of inflation even without accommodative monetary policies.
Demand-pull shocks can lead to the persistent increasing of inflation even without accommodative monetary policies.
In case the central bank doesn't react to a cost-push supply shock, then this would trigger a rightward shift in the AD curve.
In case the central bank doesn't react to a cost-push supply shock, then this would trigger a rightward shift in the AD curve.
From the perspective of the Austrian school, in the labor market an increase in the price level would shift both the labor supply and labor demand schedules upward.
From the perspective of the Austrian school, in the labor market an increase in the price level would shift both the labor supply and labor demand schedules upward.
Shoe-leather costs, arising from non-anticipated inflation, refer primarily to expenses incurred due to revising price lists and menus.
Shoe-leather costs, arising from non-anticipated inflation, refer primarily to expenses incurred due to revising price lists and menus.
In the signal extraction problem that stems from price instability; consumers may interpret changes in average price levels as relative price movements.
In the signal extraction problem that stems from price instability; consumers may interpret changes in average price levels as relative price movements.
One key benefit of inflation is that it unequivocally enhances overall economic welfare by minimizing distortions across various tax brackets.
One key benefit of inflation is that it unequivocally enhances overall economic welfare by minimizing distortions across various tax brackets.
Phillips (1958) determined there was an inverse statistical correlation between annual changes in average real wages and the level of unemployment.
Phillips (1958) determined there was an inverse statistical correlation between annual changes in average real wages and the level of unemployment.
When policymakers are always attempting to decrease economic situations, there is an increasing the inflation if they are underestimating those situations.
When policymakers are always attempting to decrease economic situations, there is an increasing the inflation if they are underestimating those situations.
Within the type of hybrid Phillips curve, the NKPC lines up and researchers started estimating when there is an inclusion of the lagged measure.
Within the type of hybrid Phillips curve, the NKPC lines up and researchers started estimating when there is an inclusion of the lagged measure.
The post-GFC conjecture known as the 'Phillips curve is dead' does imply the effect of actions by central banks push inflations and unemployment effects in different directions.
The post-GFC conjecture known as the 'Phillips curve is dead' does imply the effect of actions by central banks push inflations and unemployment effects in different directions.
Gudmundsson, T and Portillo (2024) find new Phillips Curves which are much higher than existing relationships, that have data beyond historic levels, post-pandemic.
Gudmundsson, T and Portillo (2024) find new Phillips Curves which are much higher than existing relationships, that have data beyond historic levels, post-pandemic.
Shifts in the LM curve always lead to a movement along the AD curve, regardless of the underlying cause.
Shifts in the LM curve always lead to a movement along the AD curve, regardless of the underlying cause.
In Dynamic Stochastic General Equilibrium (DSGE) models, central banks are often assumed to directly control the nominal money base.
In Dynamic Stochastic General Equilibrium (DSGE) models, central banks are often assumed to directly control the nominal money base.
According to Paul Volcker's definition, price stability is achieved when long-term inflation expectations have a material effect on economic and financial behavior.
According to Paul Volcker's definition, price stability is achieved when long-term inflation expectations have a material effect on economic and financial behavior.
The European Central Bank (ECB) considers climate change considerations as its primary goal, superseding other economic objectives.
The European Central Bank (ECB) considers climate change considerations as its primary goal, superseding other economic objectives.
In the short term, there is generally no conflict between achieving price stability and pursuing other macroeconomic goals.
In the short term, there is generally no conflict between achieving price stability and pursuing other macroeconomic goals.
Under a hierarchical mandate, a central bank ensures price stability is achieved before pursuing other co-equal objectives.
Under a hierarchical mandate, a central bank ensures price stability is achieved before pursuing other co-equal objectives.
The Federal Reserve operates under a strict hierarchical mandate, prioritizing price stability above all other economic goals.
The Federal Reserve operates under a strict hierarchical mandate, prioritizing price stability above all other economic goals.
A hierarchical mandate implies that inflation must be immediately stabilized, regardless of the potential impact on output.
A hierarchical mandate implies that inflation must be immediately stabilized, regardless of the potential impact on output.
The primary advantage of using the GDP deflator as a price index is that it explicitly accounts for the impact of imported goods on domestic prices.
The primary advantage of using the GDP deflator as a price index is that it explicitly accounts for the impact of imported goods on domestic prices.
In the Euro Area, the Harmonized Index of Consumer Prices (HICP) includes all costs related to owner-occupied housing.
In the Euro Area, the Harmonized Index of Consumer Prices (HICP) includes all costs related to owner-occupied housing.
Headline inflation is always a more reliable indicator of underlying purchasing power trends than core inflation.
Headline inflation is always a more reliable indicator of underlying purchasing power trends than core inflation.
Monetary policy can effectively rectify fluctuations caused by temporary disturbances to supply, like a sudden increase in oil prices, by swiftly adjusting interest rates.
Monetary policy can effectively rectify fluctuations caused by temporary disturbances to supply, like a sudden increase in oil prices, by swiftly adjusting interest rates.
Core inflation measures are advantageous because they always align perfectly with the price experiences of domestic economic agents.
Core inflation measures are advantageous because they always align perfectly with the price experiences of domestic economic agents.
Filtering headline inflation solely along a time dimension fails to adequately address sectors exhibiting idiosyncratic volatility.
Filtering headline inflation solely along a time dimension fails to adequately address sectors exhibiting idiosyncratic volatility.
The ECB's Persistent and Common Component of Inflation (PCCI) primarily targets the exclusion of energy and food prices.
The ECB's Persistent and Common Component of Inflation (PCCI) primarily targets the exclusion of energy and food prices.
The advantage of core inflation measures is they are readily computed by the general public in a well-defined and transparent way.
The advantage of core inflation measures is they are readily computed by the general public in a well-defined and transparent way.
A point target for inflation gives less room for interpretation compared to a range.
A point target for inflation gives less room for interpretation compared to a range.
Announcing an inflation target range always enhances policy credibility by showcasing the central bank's commitment to precision.
Announcing an inflation target range always enhances policy credibility by showcasing the central bank's commitment to precision.
A symmetric tolerance band around a point target is better than an asymmetric band because asymmetry cannot lead to biases.
A symmetric tolerance band around a point target is better than an asymmetric band because asymmetry cannot lead to biases.
Under an inflation-level targeting regime, the variance of the price level is finite in the long run.
Under an inflation-level targeting regime, the variance of the price level is finite in the long run.
Price-level targeting is particularly well-suited for economies facing frequent one-off shocks, as it allows for greater flexibility in monetary policy.
Price-level targeting is particularly well-suited for economies facing frequent one-off shocks, as it allows for greater flexibility in monetary policy.
Average inflation targeting allows for greater flexibility while keeping inflation expectations anchored.
Average inflation targeting allows for greater flexibility while keeping inflation expectations anchored.
The Federal Reserve's adoption of flexible average inflation targeting in August 2020 signaled a commitment to permanently suppress inflation below 2 percent to anchor long-term expectations.
The Federal Reserve's adoption of flexible average inflation targeting in August 2020 signaled a commitment to permanently suppress inflation below 2 percent to anchor long-term expectations.
A one-off price increase is what defines inflation.
A one-off price increase is what defines inflation.
Monetary policy is neutral, in that it impacts inflation but not output.
Monetary policy is neutral, in that it impacts inflation but not output.
A persistent decrease of the money stock in excess of output leads to inflation.
A persistent decrease of the money stock in excess of output leads to inflation.
A close relationship between money growth and price inflation always exists over short and long-term horizons alike.
A close relationship between money growth and price inflation always exists over short and long-term horizons alike.
As output nears full capacity, the AS curve flattens due to decreasing marginal costs of production.
As output nears full capacity, the AS curve flattens due to decreasing marginal costs of production.
Demand-pull inflation originates from upward pressures in the costs of goods and services.
Demand-pull inflation originates from upward pressures in the costs of goods and services.
Demand-pull and cost-push shocks cannot be made to be monetary phenomena.
Demand-pull and cost-push shocks cannot be made to be monetary phenomena.
In the short run, the economy determines the potential level and potential ouput.
In the short run, the economy determines the potential level and potential ouput.
If the central bank reacts to a supply-side shock by adjusting monetary policy, it will result in a temporary, one-time increase in the price level.
If the central bank reacts to a supply-side shock by adjusting monetary policy, it will result in a temporary, one-time increase in the price level.
A firm and credible commitment to price stability can be derived without a central bank.
A firm and credible commitment to price stability can be derived without a central bank.
The effective lower bound is a high level of avoidance to raise inflation targets to 4%.
The effective lower bound is a high level of avoidance to raise inflation targets to 4%.
A high level of CPI inflation has been seen in almost all advanced economies.
A high level of CPI inflation has been seen in almost all advanced economies.
Shoe-leather costs and menu costs are both completely avoided if inflation is anticipated.
Shoe-leather costs and menu costs are both completely avoided if inflation is anticipated.
If prices are already stable, new markets and resources are introduced.
If prices are already stable, new markets and resources are introduced.
The revenue called monetary seignorage refers to the profit that a government can earn from creating an AI system and issuing currency to manage central bank decisions.
The revenue called monetary seignorage refers to the profit that a government can earn from creating an AI system and issuing currency to manage central bank decisions.
In the late 1950s, Phillips made a direct correlation between average nominal wages and the rate of unemployment.
In the late 1950s, Phillips made a direct correlation between average nominal wages and the rate of unemployment.
The objectives for inflation and unemployement are exploited into 3 different combination sets.
The objectives for inflation and unemployement are exploited into 3 different combination sets.
Flashcards
What causes LM curve shifts?
What causes LM curve shifts?
Changes in money supply/demand not driven by output/interest rates.
How does monetary policy affect output?
How does monetary policy affect output?
Affecting output by modifying the nominal money base.
How do central banks operate?
How do central banks operate?
Setting short-run interest rates based on money demand.
What does price stability deliver?
What does price stability deliver?
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Pervasive inflation influence.
Pervasive inflation influence.
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Price stability enables what for decision making?
Price stability enables what for decision making?
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Price stability means?
Price stability means?
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Besides price stability, what are other central bank goals?
Besides price stability, what are other central bank goals?
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Modern central banks consider?
Modern central banks consider?
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Price stability ensures..?
Price stability ensures..?
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What conflicts with price stability?
What conflicts with price stability?
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What is the result of climateflation, fossilflation and disaster risks?
What is the result of climateflation, fossilflation and disaster risks?
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What is a hierarchical mandate?
What is a hierarchical mandate?
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What is a dual mandate?
What is a dual mandate?
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What is the role of the European Central Bank (ECB)?
What is the role of the European Central Bank (ECB)?
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What is the role of Swiss National Bank?
What is the role of Swiss National Bank?
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What priorities does the United State's Federal Reserve focus on?
What priorities does the United State's Federal Reserve focus on?
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When to allow inflation deviation?
When to allow inflation deviation?
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Selection of price index
Selection of price index
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Why are the important short-run differences?
Why are the important short-run differences?
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What indicates CPI(consumer price index)
What indicates CPI(consumer price index)
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What is core inflation?
What is core inflation?
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How does it occur?
How does it occur?
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Policymakers and interest in the core inflation
Policymakers and interest in the core inflation
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Time dimension filter?
Time dimension filter?
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What is cross-section dimension?
What is cross-section dimension?
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Permanent standard exclusion-based measures
Permanent standard exclusion-based measures
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ECB's measures of underlying inflation includes...
ECB's measures of underlying inflation includes...
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What are disadvantages of a core inflation measures?
What are disadvantages of a core inflation measures?
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How to define price stability
How to define price stability
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Why use numerical target?
Why use numerical target?
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Why is point-target range ideal?
Why is point-target range ideal?
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What does target range signal?
What does target range signal?
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It will maintain focal point while offering flexibility
It will maintain focal point while offering flexibility
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Countries’ price stability targets?
Countries’ price stability targets?
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What is inflation targeting?
What is inflation targeting?
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What is price-level targeting?
What is price-level targeting?
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Inflation target bygones?
Inflation target bygones?
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Price level targeting is corrected?
Price level targeting is corrected?
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Price level targeting approach
Price level targeting approach
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An average inflation.
An average inflation.
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What is triggers of inflation
What is triggers of inflation
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What defines Inflation?
What defines Inflation?
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What leads to inflation?
What leads to inflation?
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What links inflation to money growth?
What links inflation to money growth?
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What causes demand-pull inflation?
What causes demand-pull inflation?
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Cost-push inflation is caused by?
Cost-push inflation is caused by?
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What are demand pull shock?
What are demand pull shock?
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Policy that consistently relies
Policy that consistently relies
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How economics analyze shifted
How economics analyze shifted
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What costs are non-anticipated inflation?
What costs are non-anticipated inflation?
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What causes non-anticipated cost?
What causes non-anticipated cost?
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How are agents affected?
How are agents affected?
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What costs come with anticipated inflation?
What costs come with anticipated inflation?
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What can be costly/effect?
What can be costly/effect?
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Societal costs of inflation include...
Societal costs of inflation include...
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Overall price instability affects?
Overall price instability affects?
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What is a benefit of inflation?
What is a benefit of inflation?
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What is Phillips Curve?
What is Phillips Curve?
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Phillips Curve says that...
Phillips Curve says that...
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Years when the unemployment rate was very strong
Years when the unemployment rate was very strong
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Phillips curve changed models by adding.
Phillips curve changed models by adding.
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As such, the curve provides what
As such, the curve provides what
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Change in nominal wage growth?
Change in nominal wage growth?
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Since the curve shows variation and economic slack?
Since the curve shows variation and economic slack?
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Economy/ Econometric terms?
Economy/ Econometric terms?
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What is empirial
What is empirial
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New inflation rate change function with.
New inflation rate change function with.
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Hybrid models are the relationship that happens with change in
Hybrid models are the relationship that happens with change in
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Since there's a relationship, is there less friction?
Since there's a relationship, is there less friction?
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Tradeoff has less information, so?
Tradeoff has less information, so?
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Study Notes
LM and AD Curves
- Changes in money supply or demand, without changes in output or the real interest rate, cause shifts in the LM curve.
- Shifts in the LM curve lead to:
- Movements along the AD curve if price changes underlie the LM curve shift.
- Shifts in the AD curve when price changes are not driving the LM curve shift.
- Monetary policy impacts output by changing the nominal money base
- Dynamic Stochastic General Equilibrium (DSGE) models are used widely in economics and central banks, assuming the central bank sets the short-run interest rate.
- A central bank determines the interest rate based on money demand and adjusts the money base as needed.
- Actions by central banks affect the AD curve, and consequently, output.
Focus of Chapter
- Price stability, as a primary objective of monetary policy
- The chapter will cover:
- Defining price stability within broader monetary policy goals
- Analyzing the source of inflation, distinguishing between monetary and non-monetary drivers
- Evaluating the costs and benefits associated with inflation
Dual Role of Price Stability
- Price stability contributes to long-term economic growth and employment prospects.
- Price stability moderates short to medium-term variability in output and employment.
Paul Volcker definition
- Price stability refers to a situation where expectations of rising or falling prices do not pervasively influence economic and financial behavior.
- Economic agents should be able to assume that real and nominal values are substantially the same over relevant planning horizons.
Central Bank Goals
- Price stability is understood as low and stable inflation, viewed as a key monetary policy goal.
- Other typical goals include:
- Achieving full employment and balanced economic growth.
- Stable financial markets to foster investment opportunities.
- Stabilizing interest rates to reduce uncertainty including climate change considerations.
- Stabilizing exchange rates to support domestic competitiveness.
Incorporating Climate Change
- The ECB has suggested incorporating climate change considerations, viewing it as a secondary goal.
- EU law considers the sustainable development of Europe, including environmental protection, as part of general economic policies.
Price Stability as a Primary Goal
- In the long run, price stability aligns with other goals, showing no trade-off between inflation and unemployment.
- In the short run, conflicts may arise with other goals, including a potential clash between the ECB's price objective and climate support objective.
Resolving Conflicts
- Conflicts in the short run lead to two types of mandates:
- Hierarchical mandate: price stability is prioritized, other goals pursued as long as price stability is achieved.
- Dual mandate: aims to achieve two co-equal objectives, such as price stability and maximum employment.
- A good communication policy is crucial for central banks, even under a dual mandate.
Hierarchical Mandates: Examples
- ECB: price stability is the primary objective but without compromising general economic policies.
- Bank of England (BoE): maintains price stability while supporting the UK's broader economic objectives.
- Swiss National Bank (SNB): focuses on price stability but considers the development of the economy.
Dual Mandate: Example
- The Fed's goals include maximum employment, stable prices, and moderate interest rates, without a clear hierarchy.
Implementation Details
- Hierarchical mandates towards price stability do not require keeping inflation constant in the short-run, preventing excessive output fluctuations.
- Inflation can deviate from long-run goals for short periods, as seen with ECB's medium-term orientation.
- There is no ex-ante specified horizon as time lags are variable and uncertain.
Price Index Selection
- Defining price stability involves multiple dimensions, including selecting a price index representative of economic agents' decisions.
- Most indices follow the same trend in the long run, but notable short-run differences exist.
- Choosing a particular price index is significant.
Consumer Price Index (CPI)
- CPI advantages:
- Representative and reflects changes in consumer purchasing power.
- Easily understood, frequently published, and rarely revised.
- The ECB uses the Harmonized Index of Consumer Prices (HICP).
- The HICP includes everyday items, durable goods, and services, weighted by their share in overall consumption.
Interest-Related Costs
- Interest-related costs in the consumer price index can create communication issues for central banks, as interest rate increases to lower inflation might initially increase inflation.
- There is a call for including owner-occupied housing costs (OOH) in inflation indices.
- As of Summer 2021, the HICP covers only part of OOH costs, excluding purchases of dwellings and the estimated cost of living in an owner-occupied dwelling.
Headline versus Core Indices
- Headline inflation is affected by sector-specific short-run fluctuations like food and energy prices, which are hard to interpret.
- Monetary policy can only control inflation in the medium term.
- Monetary policy should react to persistent changes in inflation and not try to rectify temporary disturbances with one-off effects.
- Core inflation measures more accurately reflect the underlying trend in purchasing power, facilitating central bank communication.
- Core inflation measures might deviate from "price experience".
Core Index Forms
- Core indices can be filtered by:
- Time dimension: filtering temporary fluctuations from persistent inflation.
- Cross-section dimension: considering price evolutions common for all index components.
- The common goal is to filter out short-term volatility
ECB Measures
- Examples of ECB's measures of underlying inflation:
- Permanent exclusion: HICP excluding energy and food (HICPX).
- Temporary exclusion: trimmed means (10% and 30%), weighted medians.
- Frequency exclusion: supercore.
Exclusion Measures
- Permanent exclusion measures remove volatile sub-components, including HICP excluding energy and food (HICPX) and HICP excluding travel-related items, clothing, and footwear (HICPXX).
- Temporary exclusion measures exclude items on a temporary basis; examples are trimmed means (10% and 30%) and weighted means.
- Frequency exclusion measures filter out transitory components of consumer prices using econometric techniques.
Persistent Component
- The Persistent and Common Component of Inflation (PCCI) filters out the temporal component and averages the longer-term component of the HICP components of individual euro area countries.
- PCCI captures the common and persistent component in headline inflation rates across countries and items.
- PCCI relies on a complex econometric model while being useful when several idiosyncratic shocks affect items that are normally not volatile.
ECB Economic Bulletin
- The ECB’s Economic Bulletin zoomed in one these indicators of underling inflation, noting domestic inflation was elevated due to wage and pricing within the service sector.
- Domestic Inflation is affected largely by persistent wage pressures and delayed price adjustments in the service sectors.
Limits of Core Inflation
- Core inflation measures:
- Are more remote from consumers' experience.
- Tend to be less transparent and rely on various methodologies.
- Increases in headline inflation might create second-round effects, potentially leading to a misleading indication of future overall inflation.
Numerical Targets
- Defining price stability includes choosing a numerical target, which influences agents' inflation expectations. Numerical targets provide a point of reference for price and wage setting.
- A point target gives a precise focal point, but a target range signals uncertainty and provides flexibility.
Implementation
- Point targets with symmetric tolerance bands provide flexibility and maintain a clear focal point.
- Actual practices vary:
- ECB targets HICP inflation of 2%.
- BoE aims for CPI inflation of 2% with a 1% range.
- The Fed targets a 2% PCE inflation rate.
- The SNB targets a Swiss CPI growth below 2%.
- The Fed targets a 2% PCE inflation rate.
- BoE aims for CPI inflation of 2% with a 1% range.
Inflation Targeting
- Inflation targeting aims for a constant growth rate of price level.
- Price-level targeting aims at a fixed path of the price level.
- Under inflation targeting, past events are irrelevant, and variance in the price level is infinite in the long run.
- Price-level targeting rolls back any price inflation until the targeted path is reached, correcting past policy mistakes.
Tradeoff
- Initially, price-level targeting was believed to increase short-term inflation and output variability relative to inflation targeting.
- Later research suggests with moderate output persistence, price-level targeting lowers inflation variability more than inflation targeting.
- Price-level targeting improves inflation targeting in New Keynesian models if agents understand and incorporate it into their expectations, which is why it never been widely applied.
Greater Recession
- Price-level targeting has gained traction because it is especially effective when inflation is low, and policy rates approach the ELB (effective lower bound).
- With a negative shock, it’s implied growth will be temporarily increased.
- In cases of temporary shocks, accepting one-time inflation increases leads to avoiding adverse effects on ouput
Flexible Inflation
- An alternative is "average inflation targeting," aiming for a constant inflation rate (2%) over a longer period (5-10 years) allowing for more flexibility while keeping inflation expectations anchored.
Monetary Policy Framework
- This was adopted by the Fed in August 2020.
- The Fed seeks to “achieve inflation that averages 2 percent over time". Meaning sometimes it will need to “achieve inflation moderately above 2 percent for some time.”
Defining Inflation
- Generally, inflation involves a continuous increase in the economy's overall price level.
- Inflation is a process, not a one-off event.
- Inflation is an ongoing increase in the prices of most goods and services. It is neutral concerning cause.
Inflation Triggers
- Inflation is triggered by: monetary, demand-pull, and cost-push factors.
- Distinguishing monetary, demand-pull, and cost-push inflation is used to assess which extent the non-monetary inflation can lead to high inflation.
Monetary Inflation
- Milton Friedman: "Inflation is always and everywhere a monetary phenomenon."
- Equation of Exchange: 𝑀 ∗ 𝑉 = 𝑌 ∗ 𝑃
- A persistent rise of the money stock in excess of output leads to inflation
- Prices move proportionally with supply of money
- The velocity of money is constant
- Money is neutral
- Money stock affects output levels
- Central bank is to to fully control money supply
Association Between Money and Inflation
- A close relationship exists over longer-term horizons.
- Confirmation of the long-run relationship between money growth and inflation relies on countries with high money growth and inflation.
- This relationship disappears with short time horizons.
QE
- This discussion followed QE policicies during the Great Recession and the pandemic period.
Demand-Pull Inflation
- Demand-pull inflation: total demand outstrips total supply.
- Factors - an exchange rate depreciation leading to increased price competitiveness.
- Increased foreign demand for domestic products leads to prices that increase when the economy is closer to its employment level.
- Illustrated by a shift in the AD curve given the AS curve.
The AS Curve
- The AS curve shape reflects a change in price responsiveness or firms given capacity.
- Production increases with low levels of output.
- The AS curve becomes steeper as firms reach full capacity and start facing increased costs to increase output.
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