IDEAS home Printed from https://ideas.repec.org/a/bde/journl/y2015i11n02.html
   My bibliography  Save this article

Asymmetries in the relationship between inflation and activity

Author

Listed:
  • Luis Julián Álvarez
  • Ana Gómez Loscos
  • Alberto Urtasun

Abstract

Studying changes in the way inflation responds to fluctuations in activity and the possible dependence of this response on the course of the business cycle is of interest as this sensitivity is a key factor in the monetary policy transmission mechanism. Analysing price flexibility is also fundamental to determining the extent to which adjustments to shocks affecting an economy have an impact on activity and employment. Since the introduction of the common currency, inflation in the Spanish economy has behaved in a way that clearly differs depending on the course of the business cycle. Thus, during periods of expansion, demand pressures have caused inflation rates averaging over 2%. The recession that began in 2008 translated into a substantial slowing of the pace at which consumer prices rose in the Spanish economy, with inflation dropping well below 2%, even after stripping out the impact of cheaper oil prices. Consequently, the increase in the CPI excluding unprocessed food and energy prices, corrected for changes in indirect taxation and regulated prices, averaged less than 0.5% in the periods of recession. The slowing of the Spanish inflation rate during the recession is partly explained by the contraction of aggregate demand, although inflation can also be seen to be more sensitive to changes in activity [see Álvarez and Urtasun (2013) and Banco de España (2015)]. This increase in the elasticity of inflation to the degree of slack in the economy is consistent with a reduction in nominal rigidities during periods of crisis, which manifests itself in more frequent price adjustments than in the past. The information from the Banco de España’s survey on wage and price formation offers evidence of this [see Izquierdo and Jimeno (2015)]. According to the survey, the lower nominal rigidity would be mainly attributable to greater variability of demand and a higher level of market competition, together with more frequent price changes by competitors. Most recent empirical evidence from other European economies also suggests that inflation is more sensitive to the point in the business cycle [see Oinonen and Paloviita (2014) and Riggi and Venditti (2015)]. By contrast, a significant number of recent studies on the economy of the United States show inflation to be less sensitive to changes in activity [see Matheson and Stavrev (2013), IMF (2013)]. Moreover, survey data suggest asymmetries exist in the way inflation responds to activity. Thus, Álvarez and Hernando (2007) find that Spanish firms respond more to the falling demand typical of recessions than to increases in expansionary periods. Although this evidence seems to suggest that inflation behaves differently over the course of the economic cycle, there is a shortage of formalised analysis considering this feature. In general, the literature assumes that inflation’s response to activity remains constant, regardless of the point in the cycle. Nevertheless, it is worth exploring the extent to which inflation responds differently in different business cycle phases, and it is also pertinent to assess whether the behaviour of inflation during the current recovery differs from that in other expansionary phases. In this context, this article describes empirical specifications of the relationship between inflation and output that allow the response of prices to changes in activity to be assymmetric over expansionary and recessionary phases, as suggested by Chart 1. Specifically, in the second section various estimates of asymmetric Phillips curves are presented that take into account the effect of inflation expectations on current inflation. The article ends with some concluding remarks.

Suggested Citation

  • Luis Julián Álvarez & Ana Gómez Loscos & Alberto Urtasun, 2015. "Asymmetries in the relationship between inflation and activity," Economic Bulletin, Banco de España, issue NOV, pages 3-9, November.
  • Handle: RePEc:bde:journl:y:2015:i:11:n:02
    as

    Download full text from publisher

    File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/InformesBoletinesRevistas/BoletinEconomico/15/Nov/Files/be1511-art2e.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Andrea Stella & James H. Stock, 2012. "A state-dependent model for inflation forecasting," International Finance Discussion Papers 1062, Board of Governors of the Federal Reserve System (U.S.).
    2. Gerhard Bry & Charlotte Boschan, 1971. "Foreword to "Cyclical Analysis of Time Series: Selected Procedures and Computer Programs"," NBER Chapters, in: Cyclical Analysis of Time Series: Selected Procedures and Computer Programs, pages -1, National Bureau of Economic Research, Inc.
    3. Gerhard Bry & Charlotte Boschan, 1971. "Cyclical Analysis of Time Series: Selected Procedures and Computer Programs," NBER Books, National Bureau of Economic Research, Inc, number bry_71-1, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. A. Moutaabbid, 2024. "Les determinants de la dynamique des salaires en France : approches macro et sectorielles par la courbe de Phillips," Documents de Travail de l'Insee - INSEE Working Papers 2024-20, Institut National de la Statistique et des Etudes Economiques.
    2. Álvarez, Luis J. & Sánchez, Isabel, 2019. "Inflation projections for monetary policy decision making," Journal of Policy Modeling, Elsevier, vol. 41(4), pages 568-585.
    3. khan, sajawal, 2018. "Managing the Expectations and Monetary Policy effectiveness: Role of Inflation Targeting," MPRA Paper 93170, University Library of Munich, Germany, revised 20 Feb 2019.
    4. Ciccarelli, Matteo & Osbat, Chiara, 2017. "Low inflation in the euro area: Causes and consequences," Occasional Paper Series 181, European Central Bank.
    5. Juan Carlos Berganza & Pedro del Río & Fructuoso Borrallo, 2016. "Determinants and implications of low global inflation rates," Occasional Papers 1608, Banco de España.
    6. Luis J. Álvarez & Isabel Sánchez, 2017. "A suite of inflation forecasting models," Occasional Papers 1703, Banco de España.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Maximilian Grimm & Òscar Jordà & Moritz Schularick & Alan M. Taylor, 2023. "Loose Monetary Policy and Financial Instability," NBER Working Papers 30958, National Bureau of Economic Research, Inc.
    2. Monica Billio & Roberto Casarin & Francesco Ravazzolo & Herman K. van Dijk, 2013. "Interactions between eurozone and US booms and busts: A Bayesian panel Markov-switching VAR model," Working Paper 2013/20, Norges Bank.
    3. Stefano Magrini & Margherita Gerolimetto & Hasan Engin Duran, 2011. "Understanding the lead/lag structure among regional business cycles," Working Papers 2011_06, Department of Economics, University of Venice "Ca' Foscari".
    4. Ard den Reijer, 2006. "The Dutch business cycle: which indicators should we monitor?," DNB Working Papers 100, Netherlands Central Bank, Research Department.
    5. J. Cuñado & L. Gil-Alana & F. Gracia, 2009. "US stock market volatility persistence: evidence before and after the burst of the IT bubble," Review of Quantitative Finance and Accounting, Springer, vol. 33(3), pages 233-252, October.
    6. Esther Fernández Galar & Javier Gómez Biscarri, 2003. "Revisiting the Ability of Interest Rate Spreads to Predict Recessions: Evidence for a," Faculty Working Papers 04/03, School of Economics and Business Administration, University of Navarra.
    7. Claessens, Stijn & Kose, M. Ayhan & Terrones, Marco E., 2012. "How do business and financial cycles interact?," Journal of International Economics, Elsevier, vol. 87(1), pages 178-190.
    8. Cyrille Lenoel & Garry Young, 2020. "Real-time turning point indicators: Review of current international practices," Economic Statistics Centre of Excellence (ESCoE) Discussion Papers ESCoE DP-2020-05, Economic Statistics Centre of Excellence (ESCoE).
    9. Harding, Don & Pagan, Adrian, 2011. "An Econometric Analysis of Some Models for Constructed Binary Time Series," Journal of Business & Economic Statistics, American Statistical Association, vol. 29(1), pages 86-95.
    10. Layton, Allan P. & Katsuura, Masaki, 2001. "Comparison of regime switching, probit and logit models in dating and forecasting US business cycles," International Journal of Forecasting, Elsevier, vol. 17(3), pages 403-417.
    11. Juliana Ávila Vélez & Álvaro José Pinzón Giraldo, 2015. "¿Están sincronizados los ciclos económicos en Latinoamérica?," Borradores de Economia 12438, Banco de la Republica.
    12. Laurent Ferrara & Dominique Guégan, 2006. "Detection of the Industrial Business Cycle using SETAR Models," Journal of Business Cycle Measurement and Analysis, OECD Publishing, Centre for International Research on Economic Tendency Surveys, vol. 2005(3), pages 353-371.
    13. Julián Caballero & Christian Upper, 2023. "What happens to EMEs when US yields go up?," BIS Working Papers 1081, Bank for International Settlements.
    14. Taylor, Alan M. & Schularick, Moritz & Jordà , Òscar, 2011. "When Credit Bites Back: Leverage, Business Cycles, and Crises," CEPR Discussion Papers 8678, C.E.P.R. Discussion Papers.
    15. João Victor Issler & Hilton Hostalacio Notini & Claudia Fontoura Rodrigues, 2013. "Constructing coincident and leading indices of economic activity for the Brazilian economy," OECD Journal: Journal of Business Cycle Measurement and Analysis, OECD Publishing, Centre for International Research on Economic Tendency Surveys, vol. 2012(2), pages 43-65.
    16. Zivile Zekaite & Gabe de Bondt & Elke Hahn, 2017. "Alice: A New Inflation Monitoring Tool," EcoMod2017 10414, EcoMod.
    17. Martínez-Martín, Jaime & Rusticelli, Elena, 2021. "Keeping track of global trade in real time," International Journal of Forecasting, Elsevier, vol. 37(1), pages 224-236.
    18. Mariam Camarero & María Dolores Gadea-Rivas & Ana Gómez-Loscos & Cecilio Tamarit, 2019. "External imbalances and recoveries," Working Papers 1912, Department of Applied Economics II, Universidad de Valencia.
    19. Mikkel Hermansen & Oliver Röhn, 2017. "Economic resilience: The usefulness of early warning indicators in OECD countries," OECD Journal: Economic Studies, OECD Publishing, vol. 2016(1), pages 9-35.
    20. Harding, Don & Pagan, Adrian, 2002. "Dissecting the cycle: a methodological investigation," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 365-381, March.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bde:journl:y:2015:i:11:n:02. See general information about how to correct material in RePEc.

    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 CitEc recognized a bibliographic reference but did not link an item in RePEc 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 RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Ángel Rodríguez. Electronic Dissemination of Information Unit. Research Department. Banco de España (email available below). General contact details of provider: https://edirc.repec.org/data/bdegves.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.