The empirical analysis in this paper of the factors underlying the recent acceleration of price inflation in Germany was made in order to see whether price expectations give a satisfactory explanation of recent price behavior in Germany. Specifically, the hypothesis is tested that price expectations exercise at least a partially independent influence on actual price behavior. The paper differs from earlier analyses in that it uses a method for quantifying price survey results to derive an explicit time series of price expectations. Section I describes the method used and shows the derived series of expected price increases. Section II tests several expectations hypotheses, and Section III presents an assessment of the influence of price expectations on actual price behavior in the recent past. Some conclusions are set out in Section IV.
The pace of price inflation in Germany has recently accelerated strongly. In the case of industrial producer prices, the acceleration began with the first signs of a new upswing in the beginning of 1972. In earlier business cycles industrial producer prices showed a distinct pattern of at least slow rises, if not declines, during the downswing and even after the lowest point of the cycle was reached. Chart 1 shows the development of industrial producer prices during the cyclical downswings and at the beginning of upswings for the past three cycles. While the increase of the index of industrial producer prices during the downswing of the earlier two cycles, which lasted for over two years, amounted to about 2 percent, the increase in the last cycle, which was of a similar length, was of the magnitude of 8 per cent. Consumer prices rose at an annual rate of about 5 per cent in the first half of 1972 and then accelerated in the second half to an annual increase of about 8 per cent. Since the cost of living index plays a great role in public opinion and in the price expectations of the public, price development became a major concern for economic policy.
Analysis of price inflation has recently focused increasingly on the role of price expectations in influencing the rate of inflation. A general view has emerged that when the rate of expected price increases is high the implementation of effective stabilization policies becomes much more difficult.1 Accelerating price expectations could lead to higher wage demands to compensate for the anticipated price increases; and also in such a situation, it is much easier for enterprises to raise prices (even in the absence of excessive demand pressures). By the operation of such a mechanism, price expectations might have an impact on actual price behavior.
APPENDIX Derivation of the Expected Rate of Inflation
Expressing the outcomes of the survey as a random variable (X), the distribution function for the subset of enterprises expecting prices to fall may be written as:
Fx(–s), where the interval (–s,+s indicates the area where no price changes are expected.
Commission of the European Community, Directorate-General for Economic and Financial Affairs, Report of the Results of the Business Surveys Carried Out Among Heads of Enterprises in the Community (Brussels), various issues.
Commission of the European Community, The Harmonized Business Surveys in the Community: Principles and Methods (Brussels, November 1967).
Goldstein, Morris, “The Trade-Off Between Inflation and Unemployment: A Survey of the Econometric Evidence for Selected Countries,” Staff Papers, Vol. 19 (November 1972), pp. 647–98.
Grätz, Wilfred, and Adalbert Knöbl, “Erwartungswerte in der Ökonomie, Investitionsund Preiserwartungen, Quantifizierungsmethode,” Forschungsbericht, Nr. 70 (Institut für Höhere Studien, Vienna, July 1972).
Nordhaus, W.D., and W.A.H. Godley, “Pricing in the Trade Cycle,” Economic Journal, Vol. 82 (September 1972), pp. 853–82.
Parkin, M., “Incomes Policy: Some Further Results on the Determination of the Rate of Change of Money Wages,” Economica, Vol. 37 (November 1970), pp. 386–401.
Roussens, Stephen W., ed., Proceedings of a Symposium on Inflation: Its Causes, Consequences and Control (New York University, 1968).
Siebert, Calvin D., and Mahmoud A. Zaidi, “The Short-Run Wage-Price Mechanism in U. S. Manufacturing,” Western Economic Journal, Vol. 9 (September 1971), pp. 278–87.
Spitäller, Erich, “Prices and Unemployment in Selected Industrial Countries,” Staff Papers, Vol. 18 (November 1971), pp. 528–69.
Mr. Knöbl, an economist in the Central European Division of the European Department, is a graduate of the Hochschule für Welthandel, Vienna, and was a scholar at the Institute for Advanced Studies and Scientific Research, Vienna.
This view has been variously expressed in the German Government’s Annual Economic Report, 1973, in the reports of the German Council of Economic Experts, and in the Deutsche Bundesbank’s Monthly Report (Frankfurt am Main), various issues.
The Directorate-General for Economic and Financial Affairs of the Commission of the European Community publishes the Report of the Results of the Business Surveys Carried Out Among Heads of Enterprises in the Community (Brussels).
Excluding construction, food, beverages, and tobacco.
The conduct of the surveys and the presentation of results are described in detail in: Commission of the European Community, The Harmonized Business Surveys in the Community: Principles and Methods (Brussels, November 1967).
The method was developed in collaboration with two Austrian colleagues. Details are given in Wilfrid Grätz and Adalbert Knöbl, “Erwartungswerte in der Ökonomie, Investitions- und Preiserwartungen, Quantifizierungsmethode,” Forschungsbericht, Nr. 70 (Institut für Höhere Studien, Vienna, July 1972). At about the same time, basically the same method was developed by J. S. Carlson and M. Parkin. The method was presented at the Fund by Mr. Parkin in September 1972.
The numbers below the coefficients are the T-ratios.
Solow tested basically the same price equation for the United States and the United Kingdom, but he did not have an observed series of price expectations available. Therefore, pe was created by use of the adaptive expectations hypothesis. See R. M. Solow, Price Expectations and the Behavior of the Price Level, (Manchester University Press, 1969).