Diapositive 1

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Hubert Kempf Economic policies Master in
economics
Lecture 11 Inflation and monetary policy
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Inflation and monetary policy
1 Inflation dynamics recent trends and
monetary policy strategy issues 2 Inflation
and monetary policy strategies an overview
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1 Inflation dynamics
1.1 Global trends 1.2 Price developments in
the euro area 1.3 Monetary policy / strategy
implications
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1.1 Recent trends global disinflation
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Tentative explanations

• 1 Good Luck?
• absence of adverse supply shocks in the 1990s
• positive supply shock new economy
• Positive supply change globalisation
• 2 Good Practices?
• inventories
• price and wage setting in a context of well
  anchored inflation expectations
• increased competition
• 3 Good Policies?
• stability-oriented macroeconomic policies

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1.2 Price developments in the euro area
Note The chart shows quarter-on-quarter (red)
and year-on-year (blue) inflation, and its
average value over three sub-periods that have
been identified by breakpoint tests.
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HICP and core inflation
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Inflation persistence in the Euro Area Macro
evidence
Inflation de LT
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• Price stickiness micro data evidence
• Eurosystem Inflation Persistence Network
• - Analysis of CPI micro data
• - Analysis of producer prices
• - Survey evidence (à la Blinder, 1998)
• Based on Price Setting in the euro area Some
  stylised facts from Individual Consumer Price
  Data by Dhyne, Álvarez, Le Bihan, Veronese,
  Dias, Hoffmann, Jonker, Lünnemann, Rumler and
  Vilmunen (2005)

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Raw data (millions of) individual price records
from data underlying the CPI Common sample 50
product categories representative of CPI 10 euro
area countries AT, BE, DE, ES, FR, FI, IT, LU,
NE, PT Countries not covered GR, IR (3 of
area GDP) Period covered January 1996 -
December 2001
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Fact 1 prices change infrequently (on average
once every year) Average frequency of price
changes for the euro area 15.1 per month.
Average duration of a price spell (based on
indirect estimators) 4 to 5 quarters. Compared
to the US price adjustment in the euro area
less frequent(respective US figures are around
25 and 2 quarters)

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Product level price duration - Euro area vs
US(product averages)
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Fact 2 When they occur, price changes tend to be
quite large Absolute magnitude around 8-10 in
the retail sector and about 5 in the producer
sector The magnitude of price reductions
(10) is roughly similar to that of price
increases (8). Therefore, price of goods not
changed around average or past inflation

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Sectoral ranking. Price changes are - very
frequent for energy (oil products-F78) and
unprocessed food (28), - relatively infrequent
for non-en. industrial goods (9)- more so for
services (6).
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Frequency of price increases and price
decreasesEuro area figures in p.c. (using HICP
weights)
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Fact 5 Cross-country heterogeneity is relevant
but not as marked
Frequency ranges from 10 (Italy) to
23(Luxembourg)Partly related to - the
consumption structure - the statistical
treatment of sales.
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Other statistical evidence

• From country studies
• Time-dependence
• Seasonal patterns changes more frequent in
  January and September
• Durations of 12, 24 and 36 months
• State-dependence. Probability of price changes
  responds to
• Indirect tax rate changes, euro cash changeover
• level of aggregate inflation, sectoral or product
  level inflation
• variability of sectoral or product level
  inflation

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• To recap
• 1) Euro area has been hit by a series of
  cost-push shocks over the past six years
• 2) The degree of inflation persistence limited in
  the euro area and similar to that of the US
• 3) But the degree of price stickiness is
  considerable and higher than in the States

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• Policy implications (1)
• 1) A smaller degree of inflation persistence
  implies a smaller response of policy rate to
  cost-push shocks
• 2) A higher degree of price stickiness implies a
  greater effectiveness of monetary policy and a
  less activist monetary policy
• 3) But it also implies a slower response to other
  shocks (as productivity shocks) which calls for
  more a aggressive monetary policy response

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• Policy implications (2)
• Caveats
• 1) Uncertainty about the degree of inflation
  persistence and price stickiness
• 2) When inflation expectations are a key
  determinant of the degree of inflation
  persistence
• 3) Heterogeneity in price stickiness (service
  sector)

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• Policy implications (3)
• Downward price rigidity it is often argued that
  downward price rigidity implies a higher
  inflation objective to facilitate relative price
  adjustments
• ? the absence of downward price rigidity may call
  for a more ambitious inflation objective

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2 Inflation and monetary policy strategies
2.1 An overview of current strategies 2.2
Pro and cons 2.3 A focus on Inflation
targeting
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2.1- An overview of Monetary policy strategies
1 - Monetary policy framework
Discretion
Rule-based
Currency Board
Exchange Rate peg
Crawling peg
Inflation targeting
Multiple mandate
Monetary targeting
2 - communication
Simple
Complex
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2.2- Pro and cons of alternative policy regimes
1 - Exchange-rate pegging from currency board to
crawling peg
Objective peg the currency to that of a large,
low inflation country

• Pros
• provides an nominal anchor
• prevents time-inconsistency
• corrects low credibility
• monetary policy bound by a rule
• simple and clear to communicate
• can lower inflation quickly

• and cons
• loss of an independent monetary policy
  (idiosyncratic shocks)
• little scope for discretion
• transmission of shocks from the anchor country
• leaves the country open to speculative attacks
• eliminates lender-of-last-resort function

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2 Monetary targeting
Objective money growth as an nominal anchor

• Pros
• independent monetary policy
• nominal anchor
• high frequency publication of monetary
  aggregates
• monetary policy bound by a rule
• fairly easy to communicate

• and cons
• 2 big ifs
• relies on the existence of a strong relationship
  between the goal variable and the targeted
  aggrate
• the targeted aggregate must be well-controlled
  by the central bank

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3 Inflation targeting
Objective public announcement of a medium-term
numerical target for inflation with an
institutional commitment by the CB to achieve
this target

• Pros
• transparent monetary policy
• clear commitment to price stability
• accountability
• helps focus the public attention to price
  stability

• and cons
• inflation not easily controlled
• by central banks
• inflation outcomes revealed with substantial
  lags
• sole focus on inflation that may lead to larger
  output fluctuations

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4 Multiple mandate
Objective pre-emptive monetary policy without an
explicit nominal anchor

• Pros
• track records it worked well
• discretion

• and cons
• Lack transparency
• may create economic and financial uncertainty
• time-inconsistency
• absence of nominal anchor make higher inflation
  likely
• strong dependence on individuals The Magic
  Greenspan

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Conclusion
Fighting inflation more than manipulating money
supply!
Why monetary regimes and rules are important?
Because of the role played by expectations!
The dynamics of pricing behaviour and therefore
of inflation
Necessary to play on expectations!