Shotgun Wedding: Fiscal and Monetary Policy

This review describes interactions between monetary and fiscal policies that affect equilibrium price levels and interest rates by critically surveying theories about ( a) optimal anticipated inflation, ( b) optimal unanticipated inflation, and ( c) conditions that secure a nominal anchor in the sense of a unique price level path. We contrast incomplete theories whose inputs are budget-feasible sequences of government-issued bonds and money with complete theories whose inputs are bond/money strategies described as sequences of functions that map time t histories into time t government actions. We cite historical episodes that confirm the theoretical insight that lines of authority between a Treasury and a central bank can be ambiguous, obscure, and fragile.

Revisiting the relationship between unexpected inflation and output in the presence of indexation

Purpose This paper aims to investigate the relationship between output and unanticipated inflation when wages are indexed for the loss of purchasing power. The authors argue that the monetary authority remains useful when firms that face rigid demand index wages to compensate for the loss of purchasing power, unlike Fischer (1977), who suggested that monetary policy loses effectiveness when firms index wages. Design/methodology/approach This paper develops a simple theoretical model followed by an empirical investigation of the relationship between output and unanticipated inflation in the presence of indexation. The theoretical model assumes a perfectly competitive firm that produces a final good that has no close substitutes using one factor, labor. The demand for the product is rigid. The empirical work considers quarterly US data from 1982Q1 to 2017Q1 and uses the Generalized Method of Moments in which endogenous variables are instrumented using their own lags. This paper further considers the period before and after the recent global financial crisis. Findings This paper shows that unexpected inflation decreases the growth rate of output in the USA. The decrease is quantitatively and qualitatively stronger before the financial crisis than after the crisis. This finding suggests that the Federal Reserve should maintain higher expectations of inflation and then surprise the public with lower inflation rates. The results further suggest that regardless of how expectations are formed, firms and workers agree on the nominal wage that is equal to the realized marginal revenue product of labor. Originality/value This paper sheds light on the behavior of the central bank and its relative ineffectiveness in light of the recent economic recession.

Sticky Leverage

We develop a tractable general equilibrium model that captures the interplay between nominal long-term corporate debt, inflation, and real aggregates. We show that unanticipated inflation changes the real burden of debt and, more significantly, leads to a debt overhang that distorts future investment and production decisions. For these effects to be both large and very persistent, it is essential that debt maturity exceeds one period. We also show that interest rate rules can help stabilize our economy. (JEL E12, E31, E44, E52, G01, G32, G35)

Commodities Versus Stocks: Analysis of Their Performance from 2009 Through 2015

Although over the last several years one could have witnessed unprecedented interest in commodity investments, the view of commodities from an investor’s perspective is of more recent date (with the exception of precious metals). There are several reasons for investing in commodities. First of all, they let investors gain equity-like or higher returns. Then, they can help to mitigate risk and improve portfolio diversification. They can also provide a possible hedge against unanticipated inflation. The growing popularity of commodity investing has been followed by a great number of new investment vehicles that make commodity investments available to a wider audience. Thus, investors based on their risk-return criteria and individual requirements may select from a broad range of commodity-linked financial instruments. One of possibilities is investing through a commodity index. This approach is especially attractive to investors that are familiar with investing in stock indexes. In theory, commodity indexes share a similar goal: to create a broad indicator of commodity price movements, though in practice portfolio weightings, construction, and calculation methodology vary significantly from one index to another. The most important of commodity indexes are: the Thomson Reuters/Core Commodity CRB Index, the S-P Goldman Sachs Commodity Index, the Bloomberg Commodity Index (former Dow-Jones AIG Commodity Index), and the Deutsche Bank Liquid Commodity Index. The present paper is aimed at assessing return and risk characteristics of these indexes and at providing a comparative analysis of their performance in relation to the most important equity indexes, such as S-P500, FTSE100, CAC40, DAX, WIG, BUX, IBovespa, Nikkei, Shanghai Composite (SSE), TSE300 (current S-P/TSX Composite Index), and AOI (All Ords). The empirical data covers daily quotations from January 5, 2009 to December 30, 2015. To verify whether the commodity indexes returns differ significantly from the returns of equity indexes, the nonparametric Mann-Whitney test is applied. The test has been chosen as returns of commodity indexes are not normally distributed.

THE BURDEN OF UNANTICIPATED INFLATION: ANALYSIS OF AN OVERLAPPING-GENERATIONS MODEL WITH PROGRESSIVE INCOME TAXATION AND STAGGERED PRICES

Inflation is often associated with a loss for the poor in the medium and long term. We study the short-run redistributive effects of unanticipated inflation in a dynamic optimizing sticky price model of the business cycle. Agents are heterogeneous with regard to their age and their productivity. We emphasize three channels of the effect of inflation on income distribution: (1) factor prices, (2) “bracket creep,” and (3) sticky pensions. Unanticipated inflation that is caused by monetary expansion is found to reduce income inequality. In particular, an increase of the money growth rate by one standard deviation results in a 1% drop of the Gini coefficient of disposable income if extra tax revenues are transferred lump-sum to the households.

Can Earnings Innovations Explain The Inverse Relationship Between Unanticipated Inflation And Stock Returns?

Hooks (1991) argues that the explanatory power of unanticipated inflation in stock return models appears to result from the relationship of unanticipated inflation with the earnings capitalization rate and not the impact inflation has on the level or growth rate of earnings. Here we extend this line of investigation by examining the relationship between unanticipated inflation and the earnings innovation extracted from a univariate earnings forecast. We show that unanticipated inflation has no significant relationship with innovations in conventional earnings. However, we find that unanticipated inflation has a significant positive relationship with the magnitude of the earnings innovation during the 1955-85 period when earnings are adjusted to account for the effects of inflation on firms assets and liabilities.

The Effect of Anticipated and Unanticipated Inflation on Income Distribution: The Israeli Case

This paper examines the distributional effects of inflation and unemployment in Israel. Unlike previous studies, it distinguishes between the effect of expected and unexpected inflation, arguing that the latter should have a stronger effect. The empirical results show that a deterioration in macroeconomic conditions (a rise in inflation and/or unemployment) reduces the income share of the lower half of Israeli households and increases the income share of the wealthiest 20 per cent. The effect of unanticipated inflation is found, indeed, to be 67 per cent stronger than that of expected inflation.