Hutchins Roundup: Global value chains and inflation measures, optimal inflation rates, and more
Studies in this week’s Hutchins Roundup find that use of global value chains increases the disparity between the CPI and the PPI, a decline in long run interest rates increases optimal inflation, and more.
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Use of global value chains increases disparity between CPI and PPI
Using price data from 1970 to 2015 across various countries, Shang-Jin Wei and Yinxi Xie of Columbia University document that two inflation measures—the consumer price index (CPI) and the producer price index (PPI)—used to move in tandem but started to diverge after 2000. They hypothesize that increased offshoring and outsourcing has increased the length (the number of production stages) and global fragmentation of the supply chain, and this has led to a widening disparity in the goods and services included in the CPI and PPI baskets. In particular, the CPI includes all final goods and services, including those imported from abroad, while the PPI includes all domestically produced goods and services, even those that are exported. The widening disparity in the CPI and PPI baskets resulting from globalization in turn leads to lower correlation between the two price measures. The authors conclude that the divergence between PPI and CPI inflation since 2001 may call for a revision in the Taylor rule used for monetary policy.
Decline in long-run interest rates increases optimal inflation, but not one-for-one
If the decline in long-run real interest rates in advanced economies persists, nominal interest rates may be constrained by the zero lower bound more frequently. To counteract this, some economists have supported increasing the inflation target. Using a new Keynesian DSGE model, Philippe Andrade of the Bank of France and co-authors find that a 1 percentage point decline in the long-run natural rate of interest should be accommodated by an increase in the optimal inflation rate of about 0.9 percentage point—an estimate that is robust to various specifications that allow for uncertainty about key parameters in the model.
Labor demand factors are most important drivers of declining employment-to-population ratio
Using data from the Current Population Survey, Katharine Abraham and Melissa Kearney of the University of Maryland show that decreases in within-age-group employment among people aged 16 to 54 account for about 80 percent of the 4.5 percentage point decline in the employment-to-population ratio between 1999 and 2016. The authors then use causal estimates of contributing factors from existing literature to approximate the contributions of each factor to the decline in employment rates during this period. Increased trade and the introduction of robots are the most important drivers, they find, accounting for 23 and 12 percent of the decline, respectively. Increased participation in disability insurance programs (4 percent), increases in the minimum wage (4 percent), and increased incarceration rates (3 percent) are also significant factors.
Chart of the Week: Health care and college are among the inflation outliers
Quote of the week:
“A core concept of macroprudential policy is the financial cycle, that steady succession of ups and downs, of booms and busts. And each time the cycle turns, each time boom goes bust, everyone runs for the exit. Market participants sell the assets concerned, and prices tumble; investors incur losses, as do the banks which financed their investments. This shock might even hit banks which were prudent enough not to participate in the boom. The financial system is so interconnected that even they cannot escape contagion. And as goes the financial system, so goes the real economy. Credit dries up, growth drops off and everyone suffers. This story is a bit simple, of course. Still, it allows us to define two goals of macroprudential policy: First, make the financial system as a whole more resilient. Second, dampen the cycle of booms and busts,” says Sabine Lautenschläger, member of the Executive Board of the European Central Bank.
“The tools of macroprudential policy reflect these objectives. Some of them focus on increasing the resilience of market participants. Take, for example, the countercyclical buffer. It requires banks to set aside more capital in upturns to make them more resilient. Once the downturn sets in, banks can draw on the buffer, which helps them absorb losses. Furthermore, having to set aside more capital in an upturn makes it more costly for banks to grant loans. This might, as a positive side effect, dampen excessive credit growth and hence the cycle. Likewise, reducing capital requirements in a downturn may help to spur lending. Other tools focus on the general resilience of the financial system, going beyond the financial cycle. Various capital buffers have been designed for that purpose.”