The markup and inflation: evidence in OECD countries

In this paper we evaluate the dynamic inconsistency argument put forth by Kydland and Prescott (1977) and Barro and Gordon (1983) as an explanation for differences in the average inflation experience across OECD countries. The focus is on the empirical evidence relating the overall degree of competition among firms, as measured by the markup of price over marginal cost, and inflation over the 1973-88 period. The prediction is that higher markups raise the monetary authority's incentive to increase output, leading to higher equilibrium rates of inflation. We find that the markup does well in explaining cross-country differences in average inflation.

THE REAL-INTEREST-RATE GAP AS AN INFLATION INDICATOR

A long-standing area of research and policy interest is the construction of a measure of monetary policy stance. One measure that has been proposed, as an alternative to indices that employ monetary aggregates or exchange rates, is the spread between the actual real interest rate and its flexible-price, or natural-rate, counterpart. We examine the properties of the natural real interest rate and real-interest-rate gap using a dynamic stochastic general equilibrium model. Issues we investigate include the response of the gap and its components to fundamental economic shocks and the indicator and forecasting properties of the real-interest-rate gap for inflation, both in the model and in the data. Our results suggest that the real-interest-rate gap has value as an inflation indicator, supporting a neo-Wicksellian framework.

A monetary model of factor utilisation

The propagation mechanism of monetary shocks in an otherwise standard sticky-price model is examined, modified to incorporate factor hoarding in the form of variable capital utilisation rates and labour effort. In contrast to previous studies, it is found that real effects of monetary shocks can be generated at relatively low degrees of nominal rigidity. Factor hoarding enriches the propagation mechanism by flattening the marginal cost responses to monetary shocks. The assumption of labour hoarding is crucial for generating persistence, while the assumption of variable capital utilisation allows the generation of realistic investment volatility, without having to introduce capital adjustment costs.

The real interest rate gap as an inflation indicator

A long-standing area of research and policy interest is the construction of a measure of monetary policy stance. One measure that has been proposed, as an alternative to indices that employ monetary aggregates or exchange rates, is the spread between the actual real interest rate and its flexible-price, or natural-rate, counterpart. This study examines the properties of the natural real interest rate and 'real interest rate gap' using a dynamic stochastic general equilibrium model. Issues investigated include: (1) the response of the gap and its components to fundamental economic shocks; and (2) the indicator and forecasting properties of the real interest gap for inflation, both in the model and in the data. The results suggest that the real interest rate gap has value as an inflation indicator, supporting the 'neo-Wicksellian framework' advocated by Woodford.