On Monday I evaluated a detail from something that Roger Farmer said. I looked up the PDF Monetary Policy Rules and Macroeconomic Stability: Evidence And Some Theory by Richard Clarida, Jordi Gali, and Mark Gertler.
While reading thru that paper, what I read of it, I came across something that absolutely bears repeating. This begins on page 166 of the PDF (page 20 of 34 in the PDF reader):
At a minimum, the notion that the oil shocks can largely account for the volatile behavior in output during the 1970s period is open to debate...
While there is room to debate the importance of the oil shocks for real activity over this period, the case that these shocks alone account for the sustained high inflation is completely unpersuasive. Note first that the Hamilton evidence is silent on the link between the oil shocks and inflation. On the other hand, as De Long {1997} emphasizes, timing considerations make the oil shocks suspect as the leading explanation for inflation over this period. Figure III illustrates this point. The figure shows three-quarter centered moving averages of the real oil price against inflation over the period 1960:1–1997:1.
As De Long argues, the initial build-up of inflation in the late 1960s and early 1970s occurs prior to the first oil shock. Indeed, until the time of the first oil shock in 1974, the real oil price is steadily declining, while inflation is steadily rising. The real oil price then remains constant until late 1979, the period of the second major oil shock. Note again that there is a steady rise in inflation over a three-year period prior to this shock. In turn, the decline in inflation in the early 1980s appears to lead the decline in the real oil price.
While there is room to debate the importance of the oil shocks for real activity over this period, the case that these shocks alone account for the sustained high inflation is completely unpersuasive. Note first that the Hamilton evidence is silent on the link between the oil shocks and inflation. On the other hand, as De Long {1997} emphasizes, timing considerations make the oil shocks suspect as the leading explanation for inflation over this period. Figure III illustrates this point. The figure shows three-quarter centered moving averages of the real oil price against inflation over the period 1960:1–1997:1.
As De Long argues, the initial build-up of inflation in the late 1960s and early 1970s occurs prior to the first oil shock. Indeed, until the time of the first oil shock in 1974, the real oil price is steadily declining, while inflation is steadily rising. The real oil price then remains constant until late 1979, the period of the second major oil shock. Note again that there is a steady rise in inflation over a three-year period prior to this shock. In turn, the decline in inflation in the early 1980s appears to lead the decline in the real oil price.
5 comments:
When I wrote that the Fed didn't set interest rates because the Fed Funds Rate ALWAYS followed and NEVER led the market-based 3 month T-Bill, I got a lot of hoots and hollers, because - EXPECTATIONS!
http://angrybearblog.com/2012/05/who-determines-short-term-interest.html
So the idea that A precedes B, but B still causes A is not foreign to deep economic thinkers.
But I'm not going to go there, because I still don't believe in intertemporal dislocation.
I do think it's striking that in mid 70's and early 80's the inflation spike and the big oil price jump are pretty much concurrent.
I'm not impressed with YoY inflation falling faster then oil prices. Once this year's price gets baked in, it's effect on next year's inflation is nil. I think the sharp fall off from the first inflation peak, while oil is at a plateau reflects that.
Certainly there were other things influencing inflation throughout the period. In the early 80's, interest rates were sky high and that put a hell of damper on the economy. Which affects activity, which effects oil consumption - so goes the circle.
Then in the early 90's, though the detail doesn't line up, both lines broadly rise and then fall together.
But this is all out of context. I imagine the authors have some kind of monetarist agenda, and are pushing a viewpoint that makes them want to down-play the role of oil pricing. There might be a component of denialism at play.
Cheers!
JzB
Clarida et al: "the initial build-up of inflation in the late 1960s and early 1970s occurs prior to the first oil shock."
Nobody is saying oil price hikes didn't contribute to rising prices.
Clarida et al are saying it isn't rising oil prices that got inflation going in Q2, 1961.
The graph you show is funky. 3 quarter center moving average? Comparing price to % price change?
Here's a graph comparing % price change to % price change. Definitely a correlation after OPEC kicked in.
You brought up Q2 1961 -- WTF, inflation was very low then? But anyway, prior to OPEC inflation correlated to employment (which prolly reflects how close the economy is to capacity). 60's inflation, such as it was, correlated to employment.
Dan -
You raise an interesting point. Is comparing price to price change valid? My gut feeling is that it is.
I like your first graph, though.
Your second is a reference to the Phillips curve.
http://noahpinionblog.blogspot.com/2011/03/john-taylor-draws-philips-curve.html
It's not a simple relationship.
Cheers!
JzB
Jazz: "When I wrote that the Fed didn't set interest rates because the Fed Funds Rate ALWAYS followed and NEVER led the market-based 3 month T-Bill, I got a lot of hoots and hollers, because - EXPECTATIONS!"
Here's Stephen Williamson:
"In a world with forward looking people, promises about future actions matter for economic activity today - monetary policy actions need not precede effects."
Of course, that is based on an ergodic assumption and more statistical analysis than the average man can manage:
"In principle, the current state of the economy determines the likelihood of all potential future states of the economy. Then, if we know the central bank's policy rule, we know the the likelihood of all future policy actions."
But what the heck.
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