St. Louis Fed Introduces Review Part II


ST. LOUIS — The St. Louis Fed has expanded its economic research publication, Review, with Part II of the May/June issue. Unlike the traditional Reviews focus on work by St. Louis Fed economists, this supplementary Part II series includes research from economists throughout the Federal Reserve System.

William T. Gavin, editor-in-chief of Review and a vice president in the St. Louis Fed's Research Division, said the new series, which is peer-reviewed and directed by an editorial board of economists associated with the Federal Reserve System, will focus on central bank policy, current events and other economic topics.

"We intend to publish research for a wide audience, as we have been doing for decades with the Review," said Gavin. "The most important criteria for articles are usefulness, accuracy and readability."

The publication is available on the St. Louis Fed's web site:

The articles in this debut issue are:

  • "Core Inflation: A Review of Some Conceptual Issues." The notion of core inflation has played an important role in monetary policymakers' deliberations for a quarter of a century. There is still no consensus, however, on how best to measure core inflation. The most elementary and most widely used approach consists of simply excluding certain categories of prices from the overall inflation rate. This "excluding-food-and-energy" approach reflects the origin of core inflation in the turbulent decades of the 1970s. More recently, there have been many attempts to put the measurement of core inflation on a more solid statistical and theoretical footing. The newer approaches have two key features in common: (1) They adopt a more statistical rather than a behavioral (cost of living, for example) approach to the problem of price measurement; and (2) they invoke an alternative, monetary concept of inflation.

    Mark A. Wynne, a vice president and economist at the Federal Reserve Bank of Dallas, and the first director of that Reserve Bank's Globalization and Policy Institute, critically reviews various approaches to measuring core inflation by linking these approaches in a single, theoretical framework. Evaluating the competing merits of each approach, he argues that a common shortcoming is the absence of a well-formulated theory of what these measures are supposed to be capturing.

    "Ideally," says Wynne, "a central bank would be most interested in a measure of inflation that measured the rate of decline in the purchasing power of money. Unfortunately, there is no well-developed and generally agreed-upon theory that can serve as a guide to constructing such a measure."

  • "Inflation Regimes and Inflation Expectations." Average inflation rates in industrial countries have fallen substantially since the 1980s. In several cases, countries that experienced higher inflation than the industrial-country average during the '70s and '80s achieved lower-than-average inflation in the 1990s. At the same time, bond yields in industrial countries have generally fallen by more than inflation rates, reflecting increased credibility of anti-inflationarypolicies. Yet, the countries with the lowest inflation rates in recent years have not necessarily been those with the lowest bond yields.

    Joseph E. Gagnon, associate director of the Division of International Finance at the Federal Reserve's Board of Governors, offers a stark point: Monetary regimes with inflation targets that are quite different from the average inflation rate across previous decades may never be seen as fully credible over the long term by financial markets. He argues that the key to credibility over the long term is the expected value of inflation under the next regime. In setting expectations about the next regime, financial markets may look back to experiences from previous regimes over a long span of time.

    Although institutional changes such as inflation targeting and central bank independence may help to bolster credibility about future low inflation, Gagnon says it is impossible to completely prevent future changes in regimes, and thus complete long-term credibility about very low inflation may prove elusive.

    Gagnon notes that the recent recurrence of inflation in some countries (such as Argentina and Venezuela) argues for caution about the idea that a bad experience with inflation inoculates a country against future inflation. "At the very least," he says, "one should keep in mind that lessons learned may be lessons forgotten."

  • "Inflation and the Size of Government." It's commonly believed that inflation and big government are related. Song Han, a senior economist at the Federal Reserve's Board of Governors, and Casey B. Mulligan, a professor of economics at the University of Chicago, show that this economic theory is true only in special cases. They found that the strongest empirical relationship between inflation and the size of government arises during wartime. For example, inflation was fairly high during several British and American wars, and often negative after wars. Han and Mulligan found that permanently high non-defense government spending (observed across countries) seems to be weakly negatively related to inflation, while defense spending is somewhat more strongly positively related. At the same time, they note a slight increase in inflation with the size of government over time, which they cannot account for with defense spending.

  • "Inertial Taylor Rules: The Benefit of Signaling Future Policy." Charles T. Carlstrom, a senior economic advisor at the Federal Reserve Bank of Cleveland, and Timothy S. Fuerst, a professor of economics at Bowling Green State University (Ohio), trace the consequences of an energy shock on the economy under two different monetary policy rules: (1) a standard Taylor rule, by which the Fed responds to inflation and the output gap, and (2) a Taylor rule with inertia, whereby the Fed moves slowly to the rate predicted by the standard rule. Carlstrom and Fuerst show that with both stick wages and sticky prices, the outcome of an inertial Taylor rule is superior to that of the standard rule in the sense that inflation is lower and output is higher following an adverse energy shock. If prices alone are sticky, however, the results are less clear and the standard rule delivers substantially less inflation than the inertial rule in the long run.

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