Back Matter

Back Matter

Taimur Baig, Jörg Decressin, Tarhan Feyzioglu, Manmohan Kumar, and Chris Faulkner-MacDonagh
Published Date:
June 2003
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    Appendix I Index of Deflation Vulnerability—Data Sources and Definition of Variables

    Most of the data were drawn from two main sources: Haver Analytics’ EMERGE database (for emerging market economies) and the OECD’s Main Economic Indicators database (for OECD members). The Haver data are derived from national sources, and some attempt is made to harmonize data types across countries. The OECD data are high-fre-quency data (many series are available on a monthly basis). The remaining data are from the IMF’s International Financial Statistics (IFS) and World Economic Outlook (WEO) and Global Data Source databases.

    In all, 11 measures of deflationary pressure were compiled for each of the 35 economies, at least from 1994 to 2002 (or until the latest possible observation). Each measure was a binary (1/0) indicator, with a “1” reflecting possible deflationary pressure from that source.

    Prices (3 measures). Each measure of inflation scored a 1 if the rate for that quarter was less than ½ percent. Inflation was measured as a Q4/Q4 change in the price index (for CPI and core CPI) or GDP price deflator. Quarterly CPI inflation data are available for all 35 countries from the IFS database. GDP price deflators are derived from the ratio of nominal GDP (from IFS) to real GDP (from WEO and IFS). Because some emerging markets did not report core CPI to the IFS, it had to be supplemented using data from Haver, where available.

    Output Gaps (3 measures). The following measures of excess capacity and weak demand were used: (1) whether the output gap had increased by more than 2 percentage points over the past 4 quarters; (2) whether the current output gap was more than 2 percent; (3) whether real GDP growth over the past three years was less than the annual average growth over the preceding decade. Output gap data were available only for 21 countries (mostly industrial), provided by IMF desk economists. For the remaining 14 economies, a Hodrick-Prescott filter was used to create potential output data. While the smoothed approximation to potential GDP is not perfect, the estimates seemed to match recent demand and supply pressures. Using the Hodrick-Prescott filter for the industrial economies (where the output gap data are available directly) does not change the results.

    Stock Market Prices (1 measure). To measure pressures on the asset markets, this indicator measured the change in the broad measure of the stock market over the past three years (that is, change in equity prices over the past 36 months). The stock price index data were available in Datastream and were roughly comparable to the coverage of the U.S. S&P 500. If the equity market declined by at least 30 percent over the past three years, the measure scored 1.

    Exchange Rates (1 measure). The exchange rate measure scored a 1 if the real effective exchange rate (REER) had appreciated by more than 4 percent on a Q4/Q4 basis—measuring downward price pressures from the external sector. The REER was available from J.P. Morgan for all economies, except Poland, Russia, and China. J.P. Morgan’s index is not available for those countries because its base year is 1990 = 100. For those three countries, the REER was taken from IFS.

    Private, Nominal Credit Growth (Total Lending to the Private Sector, 2 measures). The following two measures of a breakdown of credit allocation were used: (1) whether Q4/Q4 credit growth was less than Q4/Q4 nominal GDP growth; and (2) whether cumulative credit growth over the past three years was less than 10 percent. Credit growth was only measured by the nominal value of credit (or lending) to the private sector, and the growth rate was measured on a year-on-year basis. The private credit data were, unfortunately, not available on a consistent basis across all countries. For most (13) emerging market economies, the only data available were from the IFS (line 32d.ZF . . . , Claims on the Private Sector). For most industrial economies, private sector credit data were available from the OECD’s MEI database (Australia, Austria, Denmark, Finland, Greece, Ireland, Italy, New Zealand, Norway, Poland, Sweden, and Switzerland). Data for the remaining euro area economies came from national sources. Data for the Group of Seven economies came from a combination of Haver data and national sources

    Money Supply Growth (1 measure). The money growth measure scored a 1 if broad money growth on a y/y basis grew slower than base money by 2 percentage points (or less) over the past eight quarters, to capture the relative efficacy of the monetary transmission mechanism. Money supply data were available for all emerging market economies, except China and Russia. For the remaining (non-euro area) economies, we used the national authorities’ definitions of broad money (where available) in the Haver database. When the data were not strictly identified as broad money, we used M3 (or M2 in the rare cases where M3 was not available). For base money, we used the value of currency in circulation as a measure of base money, and if that was not available, we used M0. For the euro area economies, it is technically possible to measure money supply growth, because the national authorities compute the national contribution to euro area money supply. However, we decided to exclude the euro area economies from this measure.

    Data Aggregation and Weighting. For the weighting procedure, countries were divided into three cohorts on the basis of the ratio of equity market capitalization to GDP. Countries that have a relatively large equity market were given greater weight. A similar scheme was used to reflect the heterogeneity in the financial sector, using the stock of outstanding private credit relative to GDP as an indicator to divide countries into three corresponding cohorts.

    A country that was in the top cohort in either category received a weight of 3 on that score, a country in the middle cohort received a weight of 2, and an economy in the bottom cohort, 1. As an example, if in an economy equity market declined by at least 30 percent and its market size was in the top cohort, it received a score of 3. In this example with 11 indicators, and weight adjustment, an economy in the top cohort for equity market size with a 30 percent decline thus receives a value of 0.23 (3/13) in the index, whereas a country in the third cohort and the requisite decline would receive a score of 0.09 (1/11).

    Appendix II Supplementary Material

    Figure A1.CPI and GDP Deflator in the Group of Seven (G-7)

    (Percent change from a year earlier)

    Source: IMF, World Economic Outlook.

    Figure A2.CPI and GDP Deflator in Other Advanced Economies

    (Percent change from a year earlier)

    Source: IMF, World Economic Outlook.

    Figure A3.CPI and GDP Deflator in Asian Economies

    (Percent change from a year earlier)

    Source: IMF, World Economic Outlook.

    Figure A4.CPI and GDP Deflator in Other Emerging Market Economies

    (Percent change from a year earlier)

    Source: IMF, World Economic Outlook.

    Figure A5.Producer Prices

    (Percent change from a year earlier)

    Source: IMF, Global Data Source.

    Figure A6.Consumer Prices and Inflation, 1801–2001: United States and United Kingdom

    Sources: For the UK, Research Paper 02/04, House of Commons Library, July 2002. For the U.S., Bureau of Labor Statistics.

    Figure A7.Yield Differential Between Nominal and Index-Linked Government Bonds

    (basis points)

    Source: Bloomberg, L.P.

    Figure A8.Commodity Prices

    Source: Bloomberg, L.P.

    1 Spot prices are monthly averages of West Texas crude oil through April 2003.

    Figure A9.GDP Growth and Output Gap in Asian Emerging Market Economies

    (Percent change from a year earlier, or as percent of potential GDP)

    Sources: For GDP growth, IMF, World Economic Outlook. For output gap, IMF staff estimates; and Haver Analytics.

    Figure A10.GDP Growth and Output Gap in Other Emerging Market Economies

    (Percent change from a year earlier, or as percent of GDP)

    Sources: For GDP growth, IMF, World Economic Outlook. For output gap, IMF staff estimates; and Haver Analytics.

    Figure A11.Equity Prices in Industrial Countries

    (Logarithmic scale; index, January 7, 2000 = 100)

    Source: Bloomberg, L.P.

    Figure A12.Equity Prices in Emerging Markets

    (Logarithmic scale; index, January 7, 2000 = 100)

    Source: Bloomberg, L.P.

    Figure A13.Price-Earnings Ratios in G-7 Economies

    Source: Thompson Financial, DataStream.

    Figure A14.Real Effective Exchange Rates

    (Index; 1990 = 100)

    Source: IMF, Information Notice System.

    1 Synthetic euro prior to January 1999.

    Figure A15.Private Sector Credit

    (Nominal credit growth - nominal GDP growth; in percent)

    Source: IMF, International Financial Statistics.

    1 Break in series between 1998–2000.

    Figure A16.Equity Prices Relative to Peak Values (Comparison of Japan, United States, and Germany)

    Source: Bloomberg, L.P.

    Figure A17.Real Residential Price Indices

    (1992 = 100)

    Source: Bank for International Settlements.

    Figure A18.Trade Shares and Exports

    Sources: IMF, Direction of Trade Statistics; and CEIC Data Company Limited.

    Figure A19.China: Regional and Global Trade

    Sources: IMF, Direction of Trade Statistics; and CEIC Data Company Limited.

    Note: China’s exports exclude those to the region.

    Region comprises Hong Kong SAR, Singapore, Thailand, Korea, Taiwan Province of China, Malaysia, Indonesia, and Philippines.

    Figure A20.China: Transmission of Deflation

    (Change in inflation in partner countries in response to a 0.7 percentage point (one standard deviation) increase in inflation in China; year-on-year rates, monthly, in percent)

    Source: IMF staff estimates.


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    The Severe Acute Respiratory Syndrome (SARS) epidemic could have substantial demand side effects with adverse consequences for the pace of activity and deflationary pressures in several countries. The analytical work in this report was completed before the extent of the fallout from SARS was recognized.

    This definition would also exclude the impact on the general price level of terms of trade shocks, such as a decline in oil prices, whose effects might be beneficial, but also temporary.

    Falling house prices may be accompanied by falling rental costs, which may impact standard measures of inflation. However, even if the decline in rents, or the rental component, is large, this by itself would not be expected to result in deflation.

    In the United States, the first two were estimated to overstate inflation by up to 0.4 percentage points, and the third added as much as another 0.7 percentage points. While recent changes to the methodology for computing the U.S. CPI have helped to reduce some of the bias, Hausman (2002) suggests that these improvements fix only secondary issues, and that substantial bias still continues. Ariga and Matsui (2003) suggest that Japanese CPI may have an upward bias of at least ½ percentage point.

    In the usual Balassa-Samuleson framework, a positive productivity shock in the tradable goods sector is expected to lead to an appreciation of the real effective exchange rate as an equilibrating mechanism. This adjustment, however, happens over a period of time. Moreover, this mechanism could be impeded in certain circumstances because of the presence of large excess capacity and underutilized pool of labor, resulting in the persistence of the shock.

    As deflation raises the real value of outstanding debts contracted in nominal terms while it generally does not raise debtors’ real capacity to service their debts, it can lead to bankruptcies which may entail real economic costs. This effect—based on Fisher’s (1933) debt-deflation-theory—hinges on the assumption that deflation is not fully anticipated.

    On the United States, see McLaughlin (1994); Akerlof, Dickens, and Perry (1996); Card and Hyslop (1997); Kahn (1997); and Altonji and Devereux (1999). For the United Kingdom, see Smith (2000); and Nickell and Quintini (2001). For Germany, see Decressin and Decressin (2002). A caveat is that the behavior of nominal wages during periods of inflation—which is most of the available evidence—may be different from the behavior of nominal wages in periods of deflation: some of the available evidence suggests that wage rigidity may be reduced during deflation.

    The arguments about the asymmetry in the costs of deflation and inflation underscore the importance for policymakers to target an appropriate inflation rate. See Section V of this paper for a discussion of this issue.

    The recent experience of Japan, where mild deflation has been accompanied by near stagnation in output, and a very different experience of China, where less persistent deflation has been accompanied by strong productivity gains and output growth, are examined in Section IV.

    The lessons from Japan’s recent experience are consistent with these three conclusions and are discussed in Section V; for details, see Bayoumi and Collyns (1999).

    Why this is so is much debated. But one of the key reasons may well be the pervasiveness of discretionary monetary policy.

    Taking an even longer period, the aggregate price level in the United Kingdom and the United States was virtually the same in 1900 as in 1700.

    In addition to the latter two, the unequal distribution of income and wealth has also been noted to be a factor.

    The discount rate was temporarily raised in response to Britain’s abandonment of the gold standard in September 1931.

    It should be remembered that gold had anchored exchange rate and monetary policy for nearly two centuries. Policymakers thought it inconceivable that, aside from the occasional revaluation, the exchange rate could float freely. Bernanke (1995) notes that the gold standard and austere fiscal policies were central tenets of the French political establishment; so much so that even the Communist party in the 1930s accepted the need for them.

    Ahearne and others (2002) highlight optimistic growth forecasts for Japan that ultimately proved to be mistaken, and caused policymakers to forestall action. In the United States, the 2001 recession was not reflected in national accounts data until July 2002, a full 16 months after the recession had started.

    Of course, a focus on demand-side indicators would make it difficult to take into account forces that predominantly reflect positive productivity shocks.

    Given the limited number of recent deflationary episodes, it was not possible to estimate the thresholds using the usual econometric techniques. The thresholds were derived instead from the recent experience of Japan, an assessment of factors underlying deflation in Hong Kong SAR, and from other empirical evidence (for instance, on the relationship between output gap and inflation). A number of simulations were undertaken by varying the size of the thresholds: the findings indicated a high degree of robustness of the results.

    There may also be some impact of increases in non-oil commodity prices, particularly grain and agricultural raw materials. With generally large inventories, metals prices have continued to be weak.

    For the non-OECD countries, output gap measures were obtained using a Hodrick-Prescott filter to derive potential output series, and where possible cross validated with alternative estimates.

    Given the lack of data on house prices in many countries, the formal analysis focused on equity prices, although changes in house prices were taken into account in individual country assessments discussed below.

    A striking exception may appear to be the U.S. dollar appreciation of the late 1990s, which occurred during rapid economic growth without raising concerns about deflation. But it was accompanied by a sharp increase in asset prices, reflecting higher expected rates of returns.

    Euro area countries were excluded in the assessment of the contribution of the money growth variable.

    An effort was also made to control for country heterogeneity in the degree of openness to trade, and exchange rate pass-through. The weighting scheme based on these factors did not substantially change the results.

    For issues relating to investor risk appetite, see Kumar and Persaud (2002).

    The estimated functional form was as follows:

    where π denotes inflation and Ugap denotes the unemployment gap; equations for each of the G-7 economies were estimated over the period 1990 to 2001 using quarterly data; robustness analysis was undertaken by estimating equations with varying sample size. A complementary formulation used output gaps with the following specification:

    where Ygap denotes the output gap. Both the output and employment gap data were obtained from the OECD database and IMF staff estimates.

    Prices have been broadly stable abstracting from one-off changes due to indirect taxes.

    Higher inflation in other euro area countries may of course help somewhat in restraining deflationary pressures in Germany.

    There is evidence that CPI understates deflation for reasons noted earlier. However, that would only mean that deflation is somewhat higher than currently measured, and not that it is getting worse.

    In addition to light manufactures, including clothing and textiles, and footwear, these include an increasing range of high technology products, such as digital cameras and camcorders, televisions, electronics, and personal computers.

    Indeed, over the past three years, the growth in total imports by China has outpaced the growth in its exports.

    A buffer zone is appealing because, as noted, inflation statistics suffer from measurement issues and possible upward biases. The benefits of an inflation buffer zone must, of course, be weighed against the costs of higher inflation rate in normal times (Bernanke, 2002).

    Meltzer (1999) argues that failure to allow the nominal exchange rate to depreciate has forced deflation onto Japan.

    From a multilateral perspective it might not be efficient to rely on this mechanism to exit deflation, particularly for large countries. This issue is noted further below.

    See Reinhart (2003b) for a discussion of the spillover effects of policy measures implemented in a large economy. For some evidence on specific spillover effects within the G-7 economies, see Kumar (2001).

    For example, from 1942–51 the Federal Reserve successfully maintained a cap on treasury bond yields.

    It is telling that in 1930 a key member of the U.S. Federal Reserve Board repeatedly argued against aggressive quantitative easing. The official claimed that it would be ineffective and most likely counterproductive; that the economy had to “pay” for the excesses of the 1920s, and that the monetary easing would only interfere with the natural process of restructuring (Goodfriend, 2001).

    See Buiter (2003) who also suggests that conventional monetary policy alone may cure deflation when used to monetize (in secondary markets if institutional constraints exist) expansionary fiscal policy.

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    207. Malaysia: From Crisis to Recovery, by Kanitta Meesook, Il Houng Lee, Olin Liu, Yougesh Khatri, Natalia Tamirisa, Michael Moore, and Mark H. Krysl. 2001.

    206. The Dominican Republic: Stabilization, Structural Reform, and Economic Growth, by Alessandro Giustiniani, Werner C. Keller, and Randa E. Sab. 2001.

    205. Stabilization and Savings Funds for Nonrenewable Resources, by Jeffrey Davis, Rolando Ossowski, James Daniel, and Steven Barnett. 2001.

    204. Monetary Union in West Africa (ECOWAS): Is It Desirable and How Could It Be Achieved? by Paul Masson and Catherine Pattillo. 2001.

    203. Modern Banking and OTC Derivatives Markets: The Transformation of Global Finance and Its Implications for Systemic Risk, by Garry J. Schinasi, R. Sean Craig, Burkhard Drees, and Charles Kramer. 2000.

    202. Adopting Inflation Targeting: Practical Issues for Emerging Market Countries, by Andrea Schaechter, Mark R. Stone, and Mark Zelmer. 2000.

    201. Developments and Challenges in the Caribbean Region, by Samuel Itam, Simon Cueva, Erik Lundback, Janet Stotsky, and Stephen Tokarick. 2000.

    200. Pension Reform in the Baltics: Issues and Prospects, by Jerald Schiff, Niko Hobdari, Axel Schimmelpfennig, and Roman Zytek. 2000.

    199. Ghana: Economic Development in a Democratic Environment, by Sérgio Pereira Leite, Anthony Pellechio, Luisa Zanforlin, Girma Begashaw, Stefania Fabrizio, and Joachim Harnack. 2000.

    198. Setting Up Treasuries in the Baltics, Russia, and Other Countries of the Former Soviet Union: An Assessment of IMF Technical Assistance, by Barry H. Potter and Jack Diamond. 2000.

    197. Deposit Insurance: Actual and Good Practices, by Gillian G.H. Garcia. 2000.

    196. Trade and Trade Policies in Eastern and Southern Africa, by a staff team led by Arvind Subramanian, with Enrique Gelbard, Richard Harmsen, Katrin Elborgh-Woytek, and Piroska Nagy. 2000.

    195. The Eastern Caribbean Currency Union—Institutions, Performance, and Policy Issues, by Frits van Beek, José Roberto Rosales, Mayra Zermeño, Ruby Randall, and Jorge Shepherd. 2000.

    194. Fiscal and Macroeconomic Impact of Privatization, by Jeffrey Davis, Rolando Ossowski, Thomas Richardson, and Steven Barnett. 2000.

    193. Exchange Rate Regimes in an Increasingly Integrated World Economy, by Michael Mussa, Paul Masson, Alexander Swoboda, Esteban Jadresic, Paolo Mauro, and Andy Berg. 2000.

    192. Macroprudential Indicators of Financial System Soundness, by a staff team led by Owen Evans, Alfredo M. Leone, Mahinder Gill, and Paul Hilbers. 2000.

    191. Social Issues in IMF-Supported Programs, by Sanjeev Gupta, Louis Dicks-Mireaux, Ritha Khemani, Calvin McDonald, and Marijn Verhoeven. 2000.

    190. Capital Controls: Country Experiences with Their Use and Liberalization, by Akira Ariyoshi, Karl Habermeier, Bernard Laurens, Inci Ötker-Robe, Jorge Iván Canales Kriljenko, and Andrei Kirilenko. 2000.

    189. Current Account and External Sustainability in the Baltics, Russia, and Other Countries of the Former Soviet Union, by Donal McGettigan. 2000.

    188. Financial Sector Crisis and Restructuring: Lessons from Asia, by Carl-Johan Lindgren, Tomás J.T. Baliño, Charles Enoch, Anne-Marie Gulde, Marc Quintyn, and Leslie Teo. 1999.

    187. Philippines: Toward Sustainable and Rapid Growth, Recent Developments and the Agenda Ahead, by Markus Rodlauer, Prakash Loungani, Vivek Arora, Charalambos Christofides, Enrique G. De la Piedra, Piyabha Kongsamut, Kristina Kostial, Victoria Summers, and Athanasios Vamvakidis. 2000.

    186. Anticipating Balance of Payments Crises: The Role of Early Warning Systems, by Andrew Berg, Eduardo Borensztein, Gian Maria Milesi-Ferretti, and Catherine Pattillo. 1999.

    185. Oman Beyond the Oil Horizon: Policies Toward Sustainable Growth, edited by Ahsan Mansur and Volker Treichel. 1999.

    184. Growth Experience in Transition Countries, 1990–98, by Oleh Havrylyshyn, Thomas Wolf, Julian Berengaut, Marta Castello-Branco, Ron van Rooden, and Valerie Mercer-Blackman. 1999.

    183. Economic Reforms in Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan, by Emine Gürgen, Harry Snoek, Jon Craig, Jimmy McHugh, Ivailo Izvorski, and Ron van Rooden. 1999.

    182. Tax Reform in the Baltics, Russia, and Other Countries of the Former Soviet Union, by a staff team led by Liam Ebrill and Oleh Havrylyshyn. 1999.

    181. The Netherlands: Transforming a Market Economy, by C. Maxwell Watson, Bas B. Bakker, Jan Kees Martijn, and Ioannis Halikias. 1999.

    180. Revenue Implications of Trade Liberalization, by Liam Ebrill, Janet Stotsky, and Reint Gropp. 1999.

    179. Disinflation in Transition: 1993–97, by Carlo Cottarelli and Peter Doyle. 1999.

    178. IMF-Supported Programs in Indonesia, Korea, and Thailand: A Preliminary Assessment, by Timothy Lane, Atish Ghosh, Javier Hamann, Steven Phillips, Marianne Schulze-Ghattas, and Tsidi Tsikata. 1999.

    177. Perspectives on Regional Unemployment in Europe, by Paolo Mauro, Eswar Prasad, and Antonio Spilimbergo. 1999.

    176. Back to the Future: Postwar Reconstruction and Stabilization in Lebanon, edited by Sena Eken and Thomas Helbling. 1999.

    175. Macroeconomic Developments in the Baltics, Russia, and Other Countries of the Former Soviet Union, 1992–97, by Luis M. Valdivieso. 1998.

    174. Impact of EMU on Selected Non-European Union Countries, by R. Feldman, K. Nashashibi, R. Nord, P. Allum, D. Desruelle, K. Enders, R. Kahn, and H. Temprano-Arroyo. 1998.

    173. The Baltic Countries: From Economic Stabilization to EU Accession, by Julian Berengaut, Augusto Lopez-Claros, Françoise Le Gall, Dennis Jones, Richard Stern, Ann-Margret Westin, Effie Psalida, Pietro Garibaldi. 1998.

    171. Monetary Policy in Dollarized Economies, by Tomás Baliño, Adam Bennett, and Eduardo Borensztein. 1998.

    Note: For information on the titles and availability of Occasional Papers not listed, please consult the IMF’s Publications Catalog or contact IMF Publication Services.

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