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Economics 311: Presentation on Inflation. Using an Econometric Model To Explain U. S. Inflation and Estimate the Natural Rate of Unemployment. “Triangle” Model of Inflation. Developed in late 1970s, intact since 1980 Two sides of the triangle are demand and supply

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Economics 311 presentation on inflation l.jpg

Economics 311:Presentation on Inflation

Using an Econometric Model

To Explain U. S. Inflation and

Estimate the Natural Rate of Unemployment


Triangle model of inflation l.jpg
“Triangle” Model of Inflation

  • Developed in late 1970s, intact since 1980

  • Two sides of the triangle are demand and supply

  • The base of the triangle is inertia


How it works explains headline pce deflator l.jpg
How it Works: ExplainsHeadline PCE Deflator

  • Demand enters through the unemployment gap (TV-NAIRU)

  • Supply shocks (changes relative to zero)

    • Food-energy effect

    • Relative price of imports

    • Change in trend productivity growth

  • Inertia: allow 24 quarters to enter

  • The technique simultaneously estimates the inflation equation coefficients and the TV-NAIRU


The tv nairu with and without supply shocks l.jpg
The TV-NAIRU with andwithout Supply Shocks



Here are the three supply shocks l.jpg
Here are the Three Supply Shocks

  • Food and Energy Effect

    • This is simply headline PCE inflation minus core PCE inflation

  • Change in relative price of imports

  • Change in productivity trend growth, from the research summarized earlier

  • A Consistent Theme:

    Greenspan’s Gifts!


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Food-Energy Effect, 4-Qtr Change, 1960-2016

FAE



Change in the productivity growth trend 1960 2016 l.jpg
Change in the ProductivityGrowth Trend, 1960-2016


Now let s simulate the model for 2006 16 l.jpg
Now Let’s Simulate theModel for 2006-16

  • The next chart combines the models predictions up to 2006:Q2 with future simulations that assume:

  • Constant real oil price at $60

  • Constant current exchange rate

  • Continued trend productivity growth at 2.6


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The Dilemma thatBernanke has Inherited


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2006-16: What It Takes to Keep Core Inflation = 2.0



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Conclusion about Bernanke’s Dilemma

  • Due to long inertia lags, nobody has noticed

    • Oil prices really do get into core inflation

    • So do rising relative import prices if/when dollar falls

    • So does the productivity turnaround

  • Bernanke is now stuck with ~3.0 not 2.0 core inflation


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