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Inflation, Learning And Monetary Policy Regimes In The G-7 Economies

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  • Nicholas Ricketts
  • David Rose
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    Abstract

    In this paper, the authors report estimates of two- and three- state Markov switching models applied to inflation, measured using consumer price indexes, in the G-7 countries. They report tests that show that two-state models are preferred to simple one-state representations of the data, and argue that three-state representations are more satisfactory than two-state representations for some countries. The preferred estimation results usually include a state that features a unit root in its dynamic structure, which concurs with results of direct tests for this property. However, the multistate representation of the data shows that for all G7 countries these quasi-unit-root properties arise primarily from a few brief episodes of history, concentrated in the 1970s and associated with the major oil-price shocks. For all countries there is evidence of progress towards establishing credibility of regimes with stable inflation, and in many countries there is evidence of progress in building credibility of regimes with low inflation. Credibility refers to the ex post probability assigned to the state by the Markov model, which has a large effect on how expectations of future inflation are formed. An interesting contrast arises from the results for the United States and Canada. Whereas in Canada the credibility of a regime with historically low inflation has risen sharply in the last few years, in the United States there has been convergence on a regime with a stable, but historically average, rate of inflation and not on the alternative low-inflation regime. Dans cette etude, les auteurs presentent des estimations de modeles de Markov a changement de regime comportant deux et trois etats pour representer l'inflation, mesuree par les indices des prix a la consommation des pays du groupe des Sept. Les tests effectues revelent que les modeles a deux etats sont superieurs a ceux a etat unique et que, pour certains pays, les modeles a trois etats sont plus attrayants que ceux a deux etats. Les estimations retenues incorporent generalement un etat dont la structure dynamique est caracterisee par une racine unitaire compatible avec les resultats des tests directs de racine unitaire. Toutefois, les modeles a etats multiples indiquent que, pour tous les pays du groupe des Sept, cette propriete, de racine plutot quasi unitaire, resulte principalement de quelques evenements de courte duree, lies aux principaux chocs petroliers, qui sont surtout survenus dans les annees 70. Selon les resultats empiriques, tous les pays progressent vers l'etablissement de regimes credibles d'inflation stable, et de nombreux pays sont en voie d'implanter des regimes credibles de faible inflation. La notion de credibilite renvoie a la probabilite ex post que le modele de Markov attribue a l'etat, laquelle influe beaucoup sur la facon dont les anticipations d'inflation se forment. Un contraste interessant apparait lorsque les resultats obtenus pour les Etats-Unis a cet egard sont compares a ceux qui s'appliquent au Canada. Alors que, au Canada, la credibilite d'un regime de faible inflation s'est considerablement accrue au cours des dernieres annees, on a trouve aux Etats-Unis une convergence vers un regime caracterise par un taux d'inflation stable, mais de niveau habituellement moyen, plutot que le niveau bas du regime de faible inflation.

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    Paper provided by Bank of Canada in its series Working Papers with number 95-6.

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    Handle: RePEc:bca:bocawp:95-6

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    1. Robert A. Amano & Tony S. Wirjanto, . "An Empirical Investigation into Government Spending and Private Sector Behaviour," Working Papers 94-8, Bank of Canada.
    2. Alain DeSerres & Alain Guay & Pierre St-Amant, 1995. "Estimating and Projecting Potential Output Using Structural VAR Methodology," Macroeconomics 9504003, EconWPA.
    3. Robert A. Amano & Tony S. Wirjanto, . "The Dynamic Behaviour of Canadian Imports and the Linear-Quadratic Model: Evidence Based on the Euler Equation," Working Papers 94-6, Bank of Canada.
    4. Lewis, Karen K, 1989. "Changing Beliefs and Systematic Rational Forecast Errors with Evidence from Foreign Exchange," American Economic Review, American Economic Association, vol. 79(4), pages 621-36, September.
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    Cited by:
    1. Kichian, Maral, 1999. "Measuring Potential Output within a State-Space Framework," Working Papers 99-9, Bank of Canada.
    2. Sharon Kozicki & P.A. Tinsley, 1997. "Shifting endpoints in the term structure of interest rates," Research Working Paper 97-08, Federal Reserve Bank of Kansas City.
    3. Butler, L, 1996. "The Bank of Canada's New Quarterly Porjection Model Part 4 : A Semi- Structural Method to Estimate Potential Output : Combining Economic Theory with a Time-Series Filter," Technical Reports 77, Bank of Canada.
    4. J. Ayuso & G.L. Kaminsky & D. López Salido, . "Inflation regimes and stabilization policies, Spain 1962-1997," Studies on the Spanish Economy 10, FEDEA.
    5. Joseph E. Gagnon, 2008. "Inflation regimes and inflation expectations," Review, Federal Reserve Bank of St. Louis, issue May, pages 229-243.
    6. David R. Johnson, 1997. "Expected Inflation in Canada 1988-1995: An Evaluation of Bank of Canada Credibility and the Effect of Inflation Targets," Canadian Public Policy, University of Toronto Press, vol. 23(3), pages 233-258, September.
    7. Sharon Kozicki & Peter A. Tinsley, . "Moving Endpoints in Macrofinance," Computing in Economics and Finance 1996 _058, Society for Computational Economics.
    8. Crawford, A & Kasumovich, M, 1996. "Does Inflation Uncertainty Vary with the Level of Inflation?," Working Papers 96-09, Bank of Canada.
    9. Hogan, Seamus & Marianne Johnson & Thérèse Laflèche, 2001. "Core Inflation," Technical Reports 89, Bank of Canada.
    10. Kursat Kunter & Norbert Janssen, 2002. "Credibility Of Monetary Regimes : Is Inflation Targeting Different?," Discussion Papers 0201, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    11. David Longworth & Brian O’Reilly, 2000. "The Monetary Policy Transmission Mechanism and Policy Rules in Canada," Working Papers Central Bank of Chile 72, Central Bank of Chile.
    12. Dupasquier, Chantal & Ricketts, Nicholas, 1998. "Non-Linearities in the Output-Inflation Relationship: Some Empirical Results for Canada," Working Papers 98-14, Bank of Canada.
    13. Juan Ayuso & Graciela L. Kaminsky & David López-Salido, 2003. "Inflation regimes and stabilisation policies: Spain 1962-2001," Investigaciones Economicas, Fundación SEPI, vol. 27(3), pages 615-631, September.

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