The paper assesses inflation risks resulting from the convergence of structures of relative prices in Central and Eastern European (CEE) countries toward the European Union (EU). The basic idea of the paper is that under low downward flexibility of domestic nominal prices, the adjustment of relative price structures is likely to lead to higher inflation. The authors find that the degree of differences in the structures of relative prices in transition economies vis-à-vis EU economies has a strong negative relationship to price levels in the transition economies. Based on their calculations, the authors assess the likely future inflationary pressures that can stem from the remaining differences between the structures of relative prices in the CEE economies and the EU. The authors argue that their approach can be thought of as an extension of the standard Balassa-Samuelson explanation of international variability in price levels.
Indian food and fuel inflation has remained high for several years, and second-round effects on core inflation are estimated to be large. This paper estimates the size of second-round effects using an estimated reduced-form general equilibrium model of the Indian economy, which incorporates pass-through from headline inflation to core inflation. The results indicate that India's inflation is highly inertial and persistent. Due to second-round effects, the gap between headline inflation and core inflation decreases by about three fourths within one year as core inflation catches up with headline inflation. Large second-round effects stem from several factors, such as the high share of food in household expenditure and the role of food inflation in informing inflation expectations and wage setting. Analysis suggests that in order to durably reduce the current high inflation, the monetary policy stance needs to remain tight for a considerable length of time. In addition, progress on structural reforms to raise potential growth is critical to reduce the burden on monetary policy.
We examine the effects of unconventional monetary policy (UMP) events in the United States on asset price risk using risk-neutral density functions estimated from options prices. Based on an event study including a key exchange rate, an equity index, and five commodities, we find that “tail risk” diminishes in the immediate aftermath of UMP events, particularly downside left tail risk. We also find that QE1 and QE3 had stronger effects than QE2. We conclude that UMP events that serve to ease policies can help to bolster market confidence in times of high uncertainty.
Julia Faltermeier, Mr. Ruy Lama, and Juan Pablo Medina
We study the optimal foreign exchange (FX) intervention policy in response to a positive terms of trade shock
and associated Dutch disease episode in a small open economy model. We find that during a Dutch disease
episode tradable production drops below the socially optimal level, resulting in lower welfare under learningby-
doing (LBD) externalities. FX reserves accumulation improves welfare by preventing a large appreciation of
the real exchange rate and by inducing an efficient reallocation between the tradable and non-tradable sectors.
For an empirically plausible parametrization of LBD externalities, the model predicts that in response to a 10
percent increase in commodity prices FX reserves should increase by 1.5 percent of GDP. We also find that the
welfare gains from optimally using FX reserves are twice as high as the gains from relying only on monetary
policy. These results suggest that FX intervention is a beneficial policy to counteract the loss of competitiveness
during a Dutch disease episode.
Oya Celasun, Mr. Lev Ratnovski, and Miss Roxana Mihet
U.S. monetary policy can remain extraordinarily accommodative only if longer-term inflation expectations stay well-anchored, including in response to commodity price shocks. We find that oil price shocks have a statistically significant, but economically small impact on longer-term inflation compensation embedded in U.S. Treasury bonds. The estimated effect is larger for the post-crisis period, and robust to controlling for measures of liquidity risk premia. Oil price shocks are also correlated with the variance of longer-term inflation expectations in the University of Michigan Survey of Consumers in the post-crisis period. These results are not attributable to looser monetary policy - oil price increases were associated with expectations of a faster monetary tightening after the crisis. Overall, the findings are consistent with some impact of commodity prices on long-term inflation expectations and/or on inflation rate risk.
International Monetary Fund. External Relations Dept.
This paper presents highlights of the IMF Meetings in 1968. The main themes of the IMF Annual Meeting were referred to by President Lyndon B. Johnson of the United States in his address at the opening joint session. He described 1968 as “a year of crisis in financial markets,” and the special drawing rights facility as a “major step in international financial cooperation.” Many IMF Governors returned to the theme that the containment of the potentially disruptive consequences of the events of the past year was due chiefly to a remarkable degree of international cooperation and collaboration.
This 1999 Article IV Consultation highlights that after emerging from a prolonged period of decline in the 1980s, the economy of Trinidad and Tobago has performed well in recent years, with steady economic growth and low inflation. Although a sizable investment boom in the energy sector should contribute to faster growth in the coming years, a serious terms-of-trade shock in 1998 limited output growth. Inflation has declined to a relatively low level, although rising food prices led to some pickup in 1998. The unemployment rate, although declining, remains high, at about 14 percent.