Regime and Underlying Inflation Dynamics: ¿Generalized Comovement or Relative Price Adjustment?
Inflation is usually defined as a generalized and persistent change in the price level. But this notion seems to be restricted to à la Cagan high inflations of a monetary origin, in which absolute price change prevails. It is not obvious, though, that inflation dynamics is always dominated by a strong comovement in sectoral prices. Nor that absolute price changes predominate over relative price adjustment. What is more, it is expected that in normal times, when inflation remains at a low level, transitory movements in prices explain a high portion of inflation variability, because inflation does not follow a trend but instead evidences erratic movements that on average tend to cancel out. Under high inflation, the presence of a trend in aggregate inflation reflects in a relatively higher importance of the common component in price variations. That is, more comovement in price adjustments, which not necessarily implies the absence of persistent, medium term relative price adjustments. Aggregate inflation is the result of multiple price setting decisions in response to changes in costs of production, demand conditions and policy signals. The type of response to these impulses depends on the environment where agents make these decisions. Inflation dynamics is, thus, “regime specific” because it depends on the way economic policy, in general, and monetary policy, in particular, operate. The regime dependence of inflation dynamics was initially noted by Fisher (1982), who emphasized the role loose monetary policies could have had in perpetuating supply shocks in the United States during the ‘70s. More recently, Ball and Mankiw (1995), also discussed how sectoral price responses to shocks could be influenced by the inflationary environment. Notwithstanding this long tradition in considering inflation dynamics as “regimedependent”, the concept of regime has remained fairly vague in the literature, partly because it is an “unobservable” associated to institutional factors that define a framework to interactions between economic policy and private agents. One can try to identify regime by the observable consequences of these interactions. In particular, it can be thought that the average inflation that characterizes an economy during a period of time, the trend inflation, can be a proxy for monetary regime. This is in fact what recent literature does (see Kiley, 2006; Blake and Fernández-Corugedo, 2006; and Ascari and Ropele, 2007; among others). But trend inflation as a criteria to identify regimes can be imprecise, because it ignores sectoral prices adjustment dynamics behind a specific inflation trend. This omission can lead to at least two types of miss-specifications of regime. On the one hand, in terms of underlying relative price dynamics, a regime can precede its positive manifestation when a shock takes place. On the other hand, typical relative price adjustment dynamics cannot be the same for all economies. For small open economies, frequently subject to external disequilibrium, it is economic policy itself that is an important source of relative price variability, usually through the correction of disequilibrium in the real exchange rate (RER). In this case, the tradable-non tradable price adjustment seems to be relevant to explain aggregate price dynamics. In contrast, for industrial economies shocks to energy and food often seem to be the prevailing source of inflation variability. In both cases, it is interesting to study how the transmission of aggregate shocks of different nature can change in terms of its generalization and persistence depending on the inflationary environment. With this aim, we study inflation dynamics and its relation with inflationary regimes in Argentina and the United States during the last forty years, when both countries experimented high, moderate and low inflations. The differences in size and level of development between both economies are very significant, as it is also the case for the type of shock to which they are typically subject to. In the United States shocks to energy and food prices have hit the economy not only during the ‘70s and ‘80s, but also during the ‘90s and ‘00s. In Argentina, policy shocks, usually associated to devaluations of the currency to correct external disequilibrium or to stabilize inflation using the exchange rate as an anchor, have been dominant. We found that there is far more than a generalized and persistent movement in prices behind inflation dynamics. It also reflects persistent relative price adjustment, different from the idiosyncratic, short-run noise. Our results also show that the identification of monetary regimes only by the trend inflation can be fairly vague and limited, as it ignores underlying relative price dynamics. On the one hand, the relative importance of relative price adjustment vis à vis generalized comovement in prices depends on the regime. Under high inflation, when nominal impulses are an important source of inflation variability, comovement acquires relatively higher importance than relative price adjustment. On the contrary, when inflation is low, the converse is true. On the other hand, the incidence of aggregate shocks on inflation dynamics generally manifests in the rise of the comovement between sectoral inflations, that is, the higher inflation, the more is the comovement persistence induced by aggregate shocks. It is to note, also, that the transition from regimes of moderate inflation to regimes of high inflation is a slow process: comovement increases as inflation rises, showing no discontinuities. Also, the different nature of typical aggregate shocks can impose distinct features to inflation dynamics. For Argentina we show evidence that the importance of the tradable-non tradable dynamics is common to all regimes. For the United States, the differential adjustment between energy and food prices and the rest seems to be relevant. These distinct features of inflation dynamics should be incorporated to the modeling of inflation with monetary policy purposes. They should also be taken into account when choosing a monetary policy relevant measure of core inflation: results suggest that an ex energy & food core seems relevant for the United States, but not at all for Argentina. Finally, our results show that under a low inflation environment supply shocks become more idiosyncratic. This is clear in the case of Argentina from the low pass-through on prices after 2002 devaluation vis à vis other devaluations occurred under higher inflation environments. In this sense, a general conclusion is that macroeconomic contexts of high inflation tend to impede conventional mechanisms of price adjustment to act, favoring aggregate shocks to induce a generalized comovement with a persistent impact on the price level.
Volume (Year): 1 (2008)
Issue (Month): 52 (October - December)
|Contact details of provider:|| Postal: Reconquista 266 - C1003ABF - Buenos Aires|
Phone: (54-11) 4348-3582
Fax: (54-11) 4348-3794
Web page: http://www.bcra.gov.ar
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Richard Clarida & Jordi Galí & Mark Gertler, 2000.
"Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory,"
The Quarterly Journal of Economics,
Oxford University Press, vol. 115(1), pages 147-180.
- Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
- Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
- Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
- Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
- Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2005. "Large Devaluations and the Real Exchange Rate," Journal of Political Economy, University of Chicago Press, vol. 113(4), pages 742-784, August.
- Burstein, Ariel Tomas & Eichenbaum, Martin & Rebelo, Sérgio, 2004. "Large Devaluations and the Real Exchange Rate," CEPR Discussion Papers 4810, C.E.P.R. Discussion Papers.
- Sergio Rebelo & Ariel Burstein & Martin Eichenbaum, 2004. "Large Devaluations and the Real Exchange Rate," 2004 Meeting Papers 137, Society for Economic Dynamics.
- Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2004. "Large Devaluations and the Real Exchange Rate," NBER Working Papers 10986, National Bureau of Economic Research, Inc.
- Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2004. "Large Devaluations and the Real Exchange Rate," RCER Working Papers 513, University of Rochester - Center for Economic Research (RCER).
- Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing and the General Equilibrium Dynamics of Money and Output," The Quarterly Journal of Economics, Oxford University Press, vol. 114(2), pages 655-690.
- Guido Ascari & Tiziano Ropele, 2009. "Trend Inflation, Taylor Principle, and Indeterminacy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(8), pages 1557-1584, December.
- Guido Ascari & Tiziano Ropele, 2005. "Trend Inflation, Taylor Principle and Indeterminacy," Working Papers 93, University of Milano-Bicocca, Department of Economics, revised Oct 2005.
- Guido Ascari & Tiziano Ropele, 2009. "Trend Inflation, Taylor Principle and Indeterminacy," Quaderni di Dipartimento 097, University of Pavia, Department of Economics and Quantitative Methods.
- Ascari, Guido & Ropele, Tiziano, 2007. "Trend Inflation, Taylor Principle and Indeterminacy," Kiel Working Papers 1332, Kiel Institute for the World Economy (IfW).
- Guido Ascari & Tiziano Ropele, 2009. "Trend inflation, Taylor principle and indeterminacy," Temi di discussione (Economic working papers) 708, Bank of Italy, Economic Research and International Relations Area.
- Michael T. Kiley, 2007. "Is Moderate-to-High Inflation Inherently Unstable?," International Journal of Central Banking, International Journal of Central Banking, vol. 3(2), pages 173-201, June.
- Michael Kiley, 2004. "Is Moderate-To-High Inflation Inherently Unstable?," Econometric Society 2004 North American Summer Meetings 193, Econometric Society.
- Michael T. Kiley, 2004. "Is moderate-to-high inflation inherently unstable?," Finance and Economics Discussion Series 2004-43, Board of Governors of the Federal Reserve System (U.S.).
- Filippo Altissimo & Benoît Mojon & Paolo Zaffaroni, 2007. "Fast micro and slow macro: can aggregation explain the persistence of inflation?," Working Paper Series WP-07-02, Federal Reserve Bank of Chicago.
- Mojon, Benoît & Altissimo, Filippo & Zaffaroni, Paolo, 2007. "Fast micro and slow macro: can aggregation explain the persistence of inflation?," Working Paper Series 0729, European Central Bank.
- Tomás Castagnino & Laura D´Amato, 2008. "Regime Dependence, Common Shocks and the Inflation-Relative Price Variability Relation," BCRA Working Paper Series 200838, Central Bank of Argentina, Economic Research Department.
- repec:sae:niesru:v:164:y::i:1:p:100-109 is not listed on IDEAS
- Timothy Cogley & Thomas J. Sargent, 2002. "Evolving Post-World War II U.S. Inflation Dynamics," NBER Chapters, in: NBER Macroeconomics Annual 2001, Volume 16, pages 331-388 National Bureau of Economic Research, Inc.
- Timothy Cogley & Thomas Sargent, "undated". "Evolving Post-World War II U.S. Inflation Dynamics," Working Papers 2132872, Department of Economics, W. P. Carey School of Business, Arizona State University.
- Ricardo Reis & Mark W. Watson, 2010. "Relative Goods' Prices, Pure Inflation, and the Phillips Correlation," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(3), pages 128-157, July.
- Ricardo Reis & Mark W. Watson, 2007. "Relative Goods' Prices, Pure Inflation, and the Phillips Correlation," NBER Working Papers 13615, National Bureau of Economic Research, Inc.
- Laurence Ball & N. Gregory Mankiw, 1995. "Relative-Price Changes as Aggregate Supply Shocks," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 161-193.
- Ball, L. & Mankiw, G.H., 1992. "Relative-Price Change as Aggregate Supply Shocks," Harvard Institute of Economic Research Working Papers 1609, Harvard - Institute of Economic Research.
- Laurence Ball & N. Gregory Mankiw, 1992. "Relative-Price Changes as Aggregate Supply Shocks," NBER Working Papers 4168, National Bureau of Economic Research, Inc.
- Laurence Ball & N. Gregory Mankiw, 1993. "Relative-price changes as aggregate supply shocks," Working Papers 93-13, Federal Reserve Bank of Philadelphia.
- Todd E. Clark, 2006. "Disaggregate evidence on the persistence of consumer price inflation," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(5), pages 563-587.
- Todd E. Clark, 2003. "Disaggregate evidence on the persistence of consumer price inflation," Research Working Paper RWP 03-11, Federal Reserve Bank of Kansas City.
- Stock, James H & Watson, Mark W, 2002. "Macroeconomic Forecasting Using Diffusion Indexes," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(2), pages 147-162, April. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:bcr:ensayo:v:1:y:2008:i:52:p:87-120. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Federico Grillo)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.