E31 Price Level; Inflation; Deflation

March 13, 2011

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March 9, 2011

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March 9, 2010

Psychological factors, market sentiments, and shifts in beliefs are believed by many to play a nontrivial role in inducing and amplifying economic fluctuations. Yet, these forces are rarely considered in macroeconomic models. This paper provides an attempt to evaluate the empirical role of expectational shocks on business cycle fluctuations. The paper relaxes the conventional assumption of rational expectations to exploit observed data on survey and market expectations in the estimation of a benchmark New Keynesian model. The observed expectations are modeled as formed from a near-rational expectation formation mechanism, which assumes that economic agents use a linear perceived law of motion for economic variables that has the same structural form as the model solution under rational expectations and that they need to learn model coefficients over time. In addition to the typical structural demand, supply, and policy disturbances, the model incorporates expectation shocks, which affect the formation of expectations by the private sector. Both the best-fitting learning process and the expectations shocks are identified from the expectations data and from the interaction between expectations and realized data. The expectations shocks capture waves of optimism and pessimism that lead agents to form forecasts that deviate from those implied by their learning model and by the state of the economy. The empirical results uncover a crucial role for these novel expectations shocks as a major driving force of the U.S. business cycle. Expectation shocks regarding future real activity are the main source of economic fluctuations, since they can account for roughly half of business cycle fluctuations.

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January 1, 2009

We propose a new procedure to increase the power of panel unit root tests when used to study convergence by testing for stationarity between a group of series and their cross-sectional means. Although each differential has non-zero mean, the group of differentials has a cross-sectional average of zero for each time period by construction, and we incorporate this constraint for estimation and when generating finite sample critical values. We find strong evidence of inflation convergence soon after the implementation of the Maastricht treaty and a dramatic decrease in the persistence of the differential after the occurrence of the single currency.

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January 1, 2005

The Paper presents a model in which the exogenous money supply causes changes in the inflation rate and the output growth rate. While inflation and growth rate changes occur simultaneously, the inflation acts as a tax on the return to human capital and in this sense induces the growth rate decrease. Shifts in the model’s credit sector productivity cause shifts in the income velocity of money that can break the otherwise stable relation between money, inflation, and output growth. Applied to two accession countries, Hungary and Poland, a VAR system is estimated for each that incorporates endogenously determined multiple structural breaks. Results indicate Granger causality positively from money to inflation and negatively from inflation to growth for both Hungary and Poland, as suggested by the model, although there is some feedback to money for Poland. Three structural breaks are found for each country that are linked to changes in velocity trends, and to the breaks found in the other country.

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February 1, 2006

We explore whether forecasting an aggregate variable using information on its disaggregate components can improve the prediction mean squared error over first forecasting the disaggregates and then aggregating those forecasts, or, alternatively, over using only lagged aggregate information in forecasting the aggregate. We show theoretically that the first method of forecasting the aggregate should outperform the alternative methods in population. We investigate whether this theoretical prediction can explain our empirical findings and analyse why forecasting the aggregate using information on its disaggregate components improves forecast accuracy of the aggregate forecast of euro area and US inflation in some situations, but not in others.

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March 1, 2006

Recent contributions have suggested that technology shocks have a negative impact on hours, contrary to the prediction of standard flexible-price models of the business cycle. Some authors have interpreted this finding as evidence in favour of sticky-price models, while others have either extended flexible-price models or disputed the empirical finding itself. In this paper we estimate a variety of alternative TFP measures for a representative sample of Italian manufacturing firms and on average find a negative effect of productivity shocks on hours. Using the reported frequency of price reviews, we show that the contractionary effect is stronger for firms with more flexible prices. Price stickiness remains a crucial factor in the response of hours even if product storability or market power are allowed for. Our results hold under alternative assumptions for the stationarity of hours per capita.

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November 1, 2006

This article is related to the large recent literature on Phillips curves in sticky- price equilibrium models. It differs in allowing for the degree of price stickiness to be determined endogenously. A closed-form solution for short-term inflation is derived from the dynamic stochastic general equilibrium (DSGE) model with state-dependent pricing developed by Dotsey, King and Wolman. This generalized Phillips curve encompasses the New Keynesian Phillips curve (NKPC) based on Calvo-type price-setting as a special case. It describes current inflation as a function of lagged inflation, expected future inflation, current and expected future real marginal costs, and current and past variations in the distribution of price vintages. We find that current inflation depends positively on its own lagged values giving rise to intrinsic persistence as a source of inflation persistence. Also, we find that the state-dependent terms (that is, the variations in the distribution of price vintages) tend to counteract the contribution of lagged inflation to inflation persistence.

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July 1, 2007

We estimate the approximate nonlinear solution of a small DSGE model on euro area data, using the conditional particle filter to compute the model likelihood. Our results are consistent with previous findings, based on simulated data, suggesting that this approach delivers sharper inference compared to the estimation of the linearised model. We also show that the nonlinear model can account for richer economic dynamics: the impulse responses to structural shocks vary depending on initial conditions selected within our estimation sample.

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