Slack and Cyclically Sensitive - PowerPoint Presentation

1.  Slack and Cyclically Sensitive InflationJune 19, 2018James Stock, Harvard EconomicsMark Watson, Princeton University2018 ECB Forum on Central BankingSintra, Portugal

2. 1Where is the cyclical pressure on inflation? US:Unemployment rate 4-quarter inflationPCExFEPCE - total

3. 2Euro Area data:Unemployment rate 4-quarter inflationHICP x EuFHICP - totalWhere is the cyclical pressure on inflation?

4. 3The Flattening U.S. Phillips Curve – using PCExFE & CBO unemployment gap1984-19992000-2018q11960-1983Four-quarter changes of four-quarter inflation

5. 4Slack and Cyclically Sensitive InflationOutlineUSCan the (aggregate) PC be resuscitated by using a different slack measure? (no)Do some components move cyclically (yes)Construct index of cyclically sensitive inflation (CSI)EADo some components move cyclically (yes)Construct index of cyclically sensitive inflation (CSI)Discussion & implicationsData commentsAll data are quarterlyInflation is 4-quarter inflation (e.g. Q1-to-Q1):Changes in inflation are 4-quarter change:

6. 5US: Can the Phillips Curve be Resuscitated by Using a Different Slack Measure? Gaps and SlackThe real-time gap problem (Orphanides & van Norden (2003))Theory doesn’t provide a single gap measureThe depth of this recession might pose special problems for some slack measuresWe consider 7 gap measures: 2 CBO gaps, 5 two-sided smoother estimates of potentialAlso gap index (1st principal component)

7. 6US: Contemporaneous Phillips correlations & slopes: various gaps & PCExFE (4Q change)

8. 7US: Phillips correlations & slopes: various gaps, ctd

9. 8SectorShare (2000s)SubtotalsA. Well-measuredHousing ex utilities0.160.34Recreation services0.04Food and beverages for off-premises consumption0.08Food services and accommodations0.06Housing - energy utilities component0.020.05Gasoline and other energy goods0.03B. Some information contentOther services0.090.29Other nondurable goods0.08Transportation services0.03Motor vehicles and parts0.04Other durable goods0.02Furnishings and durable household equipment0.03Health care0.160.16C. Poorly measuredFinancial services and insurance0.080.17Clothing and footwear0.03Recreational goods and vehicles0.03NPISH0.03US: PCE Inflation Components: Measurement Issues & Cyclical PropertiesWe consider ~39% of consumption to have well-measured price inflation~17% of consumption has poorly measured price inflation. The main problems are:New/improved goodsUse of input costs instead of consumer prices for some servicesLack of market prices for some services

10. 9US: Cyclical activity measures (32 quarter band-pass filtered)The cyclical activity index (CAI) is the first principal component of the 6 band-passed activity variables

11. 10US: Cyclical Properties of PCE Components: Four ExamplesBlack: inflation component Blue: Cyclical Activity IndexCorrelation = -0.11Correlation = -0.09Correlation = 0.46Correlation = 0.48

12. 11US: Correlation of 4Q differences of 4Q inflation with Cyclical Activity IndexHousing excluding gas & electric utilities0.475Food services & accommodations0.463Food and beverages purchased for off-premises consumption0.426Recreation services0.278Recreational goods and vehicles0.255Other services0.153NPISH0.138Gas & electric utilities0.130Other durable goods0.100Furnishings & durable household equipment0.095Other nondurable goods0.061Transportation services0.019Gasoline & other energy goods-0.040Clothing & footwear-0.089Health care-0.107Financial services & insurance-0.114Motor vehicles and parts-0.366

13. 12Cyclically Sensitive Inflation: MethodsTreat the Phillips curve as a statistical measurement problemComponents each have different amounts of signal and noiseIncorporate judgmental assessment of measurement qualityEliminate Recreational goods & vehicles, Clothing & footwear, Financial services & insurance, and NPISHCSI - single slack indicator approach What are the inflation index weights that yields the most cyclical inflation index? Estimate the regression,

14. 13US: Benchmark CSI specification using CAI – estimated 1984-2018q1ComponentCorr with CAICSI weightHousing excluding gas & electric utilities0.4750.627Food services & accommodations0.4630.040Food and beverages purchased for off-premises consumption0.4260.159Recreation services0.2780.080Recreational goods and vehicles0.255excludedOther services0.1530.072NPISH0.138excludedGas & electric utilities0.130.022Other durable goods0.10Furnishings & durable household equipment0.0950Other nondurable goods0.0610Transportation services0.0190Gasoline & other energy goods-0.040Clothing & footwear-0.089excludedHealth care-0.1070Financial services & insurance-0.114excludedMotor vehicles and parts-0.3660

15. 14US: CSI, PCExFE, and PCE-all inflation (4 quarter inflation)

16. 15US: CSI Phillips correlations & slopes

17. 16EA CSI : Slack Measures and Cyclical Activity IndexEA slack measuresUnemployment gap (EC)Output gap (IMF)Band-passed activity variables:GDPCapacity utilizationIndustrial productionEA Cyclical Activity Index = average of three band-passed variables (standardized)

18. 17EA: HICP Components: 12 Second-Tier Components (Housing is ex energy)Correlation = 0.72Correlation = 0.02Correlation = 0.12Correlation = 0.16Black: inflation component Blue: Cyclical Activity Index

19. 18EA: Benchmark CSI specification using CAI – estimated 1996-2018q1Component and HICP codeConsumption share (2018)Correlation between cyclical activity index and 4-qtr change in 4-qtr inflationCSI weight (wi)Food & non-alcoholic beverages (01)0.1550.730.125Alcohol, tobacco, & narcotics (02)0.040-0.050.000Clothing & footwear (03)0.0590.160.000Housing excluding energy (04x)0.0640.020.000Furnishings, household items, & maintenance (05)0.0620.630.440Health (06)0.0480.120.042Transport goods & services (07)0.1540.210.043Communications (08)0.032-0.060.000Recreation & culture (09)0.0920.240.000Education (10)0.0100.270.011Restaurants & hotels (11)0.0980.720.338Misc. goods & services (12) 0.0920.350.000

20. 19EA CSI, HICPxEUF, and HICP-all inflation (4 quarter inflation)

21. 20Sensitivity check: Gap index instead of band-passed activity index4-quarter inflationCSI using gap indexCSI with index weights estimated (band-passed, unemployment gap, output gap). 82% of the weight is on band-passed.

22. 21Take-awaysChanging slack measures doesn’t solve the PC puzzle (US)Cyclical behavior varies substantially across components. In ways that largely make sense based on the nature of the markets (local v. global) and on measurement qualityCurrent outlook: USFrom 2013q1-2018q1, PCExFE is unchanged (1.5%), CSI has increased from 2.1% to 2.6%Current outlook: EACSI has different weights than HICPxEUF – but recent behavior is very similar2016q1-2018q1: EA-CSI increased from 0.9% to 1.2%, same as HICPxEUFNext stepsImplement monthly (12-month inflation)Work with third-tier components – especially in EA (differentiate goods and services)Resolve conceptual/empirical issue: band-passed activity index or gap or ???

23. 22Additional Slides

24. 23US: Sensitivity check: Pre-sample stabilityCorr = 0.57Corr = 0.57Other sensitivity checksRolling regressionUse all 17 componentsConstrained canonical correlations using all 7 band-pass activity variablesUse gap instead of band-passed activity indexes

25. 24US: Sensitivity check: Gap index instead of band-passed activity indexCSI inflation index differs if gap index is used instead of band-passed.If activity weights and CSI weights are chosen simultaneously, the slack variable chosen is band-passed activity index – not a gap!4-quarter change of 4-quarter inflation

26. 25US: Recent values, CSI and PCExFE (quarterly inflation)

27. 26US: PCE components and their shares, sorted by 2000-2014 shareSector1960-20141960-19791980-19992000-2014Housing and utilities0.180.170.180.18Health care0.110.070.130.16Other services0.080.080.080.09Other nondurable goods0.080.080.070.08Food and beverages for off-premises consumption0.120.160.100.08Financial services and insurance0.060.050.070.08Food services and accommodations0.060.060.070.06Motor vehicles and parts0.050.060.050.04Recreation services0.030.020.030.04Clothing and footwear0.050.070.050.03Recreational goods and vehicles0.030.030.030.03Gasoline and other energy goods0.040.040.040.03Transportation services0.030.030.030.03Furnishings and durable household equipment0.040.040.030.03Final consumption expenditures of nonprofit institutions serving households (NPISHs)0.020.020.020.03Other durable goods0.020.020.020.02

28. 27The PCE price index is computed by the Bureau of Economic Analysis (BEA)Most component price series are CPI indexes for components, computed by the Bureau of Labor Statistics (BLS)Differences between PCE-PI and CPI:PCE concept is final consumption, CPI is “out of pocket” spendingShare weights are from the NIPA surveysPCE-PI is revised for methodological changes (if possible), CPI is notSome divergence in price concepts, in which PCE uses PPI not CPI pricesThe market price component of the CPI has 211 item strataGoods and services. Nondurables: < 3 yrs life. Services: cannot be inventoried.Main sampling rotation structures:food at home, lodging, most consumer end-energy goods, telephone services, used cars, some odds and ends: Single panel sample monthlyEverything else except rent (most regions): 2 panels, alternating monthsrent: 6 panels, each sampled every 6 monthsThe market price component of the CPI has 211 item strataMarket-based CPI has several well-known problemsNew goods problem: no quality adjustment, just skip first month priceReplacement goods problem: quality adjustment by (a) hedonic regression or, if not possible, (b) production costThe PCE price index: a brief review of methods

29. 28The PCE-PI and the CPI are also computed for sectors without posted market prices. There are various methodologies:The first step is defining the unit to be priced. For exampleFor legal services: an end-consumer legal service (e.g. will), with a fixed production function (hours of attorney, legal aide, etc) and changing input wages;or, an hour of a law office’s timeFor hospital services: a service bundle (e.g., 2 day stay + 1 cardiac catheterization + 2 EKGs + 2 IV doses blood thinner drug + …)These are priced from (randomly selected) bills or interviewsOther price indexes for unpriced services include unpriced services of nonprofits (religious institutions, etc.), unpriced banking services (liquidity services)However, many services have market prices (Red Sox ticket; a room at Sonesta)Special indexes:PCE-xE: excludes gasoline & other energy goods + energy utilities component of housingPCE-xFE: also excludes food at home (but not food at restaurants)Market-based CPI (excludes all non-market price estimates)The PCE price index: a brief review of methods, ctd.

30. 29PCE (green) and component (orange): Housing ex energy util. (qtrly)Rent paid by rentersActual market rent excluding utilities6 rotating panels, surveyed every 6 monthsPrice index(t) = This month’s panel price relative  price index(t-1)Owner-equivalent rentPost-1983: Actual market rent excluding utilitiesPre-1983: Payment flows (mortgage payments, etc)6 rotating panels, index construction as for rentersMisc.Surveyed units fractionally represent rental and owned unitsBoarding schools, group homes use renter’s rent indexUtilities: CPI for water & sewer maint; CPI for garbage & trash collection

31. 30Housing: energy utilitiesElectricityCPI for electricityNatural gasCPI for utllity-provided natural gas

32. 31Health care (expenditure share 2000-2016 = 0.16): CPICPI v. PCECPI covers out-of-pocket medical (paid by consumers). PCE covers consumption of medical services. Most medical services in the U.S. do not have a market price – they are negotiated health plan pricesCPI: Outpatient physician’s services, paramedics, hospitals, nursing homesProvision-of-services concept. CPI outpatient: price of visit for a specific illness. CPI hospital (post-87): price of bundle of services provided (3-day stay + 1 catheterization + 2 EKGs +… ) by insurer reimbursement category. CPI pharma: by drug. Pre-87: cost of hospital inputsDental & other medicalCPI for dental services, CPI for other medical services

33. 32Health care (0.16): PCEPPI conceptPPI usually first transaction price rec’d by producer. For health care, PPI since 1993 is DRG-based, broken out by service providersPCE: Physician servicesPPI for physician offices. Unit is office visit for a given conditionPCE: hospital servicesPPI for hospitals. Unit is a hospital episode for a given conditionPCE: nursing homesPPI for nursing homes. Cost of inputs basis (hourly wages etc.)PCE: paramedicalPPI for paramedicalDental & other medicalUses CPIs for dental services, for other medical services

34. 33Other services (0.09)CommunicationCPI for wireless phone service, CPI for land line phone serviceInternetCPI for internet servicesEducationCPI for college education; CPI for private primary & secondary schoolsLegal, accountingCost basis (cost of 1 hr law office time, or mix of time for given service)Social servicesCost basis, some CPI (child care)Misc.CPI for postage, CPI for funeral services, CPI for haircuts; net foreign travel (complicated)

35. 34Other nondurable goods (0.08)TobaccoCPI-tobaccoPharmaceuticalsCPIs for prescription & OTC drugs, CPI for med. eqpt sold to consumersRecreational nondurablesCPIs for toys, plants & flowers, pets, photographic supplies,…Personal careVarious CPIs for personal care itemsMisc. home goodsCPIs: newspapers & magazines, household suppliesSpending abroad(net, including in-kind personal remittances) complicated, non-mkt

36. 35Food & beverages off-premises (0.08)Food & nonalcoholic beverages, off-premisesDetailed price components for food at homeAlcohol, off-premisesVarious CPIs (beer, wine, distilled spirits) for off-premises

37. 36Financial services & insurance (0.08)Financial services provided w/out paymentEstimated based on imputed below-market interest on checking account. Alternative interest rate changed to “stabilized” (smoothed) rate in 2013, revised back to 1985Financial feesCPI for checking account and other bank services (market prices). InsurancePrice index is for the value of insurance services provided (risk pooling, intermediation) = all premiums – expected losses; cost-based using PPIBrokers’ feesPPI (cost-based)

38. 37Food services & accommodations (0.06)Purchased meals & beveragesCPI for categories of purchased meals & beverages (restaurant meals, bars, fast food, etc)Institutional food & drinkUse market-based CPI for purchased meals & beverages by categoryAccommodationsCPI for purchased lodging away from home. Boarding at schools: separate (market-price) CPI

39. 38Motor vehicles & parts (0.04)New cars & trucksCPI-new cars: sticker price + 30-day average dealer markup or discount. Year to year quality changes priced on production cost.Used cars & trucksSecondary source price data, with quality adjustments when newPartsCPI for tires; CPI for parts

40. 39Recreation services (0.04)Sports centers & clubs, theaters, museums, etc.CPI for specific categories, e.g. club dues and fees; admission to sporting events. Monthly/bi-monthly/6-month sampleAudio/video & info processing servicesCPI for cable & satellite TV; CPI for film processing; CPI for video/audio rentalOtherGambling: CPI-U; pet care: CPI-veterinary services, etc.

41. 40Clothing & footwear (0.03)Market purchased clothingVarious CPIs. Note new/replacement goods issue however.Military & uniformsCost-based

42. 41Recreational goods & vehicles (0.03)Video, audio, home computersVarious CPIs including CPI for home computers, CPI for computer software and accessories, and CPI for consumer digital communications and information processing eqptSporting eqpCPI for sporting eqptRecreational booksCPI for recreational booksMusical instrumentsCPI for musical instruments

43. 42Gasoline & other energy goods (0.03)Motor fuelsCPI for motor fuelsOther fuelsCPIs for propane, kerosene, wood

44. 43Transportation services (0.03)Airline travelPPI (cost-based: passenger revenues/total passenger-miles) (however CPI is based on actual prices, currently sampled off the Web)IntracityCPI (covers taxis, busses, etc.)Intercity busses, trainsCPI (market prices)WaterCPI (ferries, etc.)

45. 44Furnishings & household durables (0.03)Furniture & beddingCPI for furniture & bedding; CPI for clocks & lamps; related CPIsHousehold appliancesVarious CPIsTools, house & garden eqptVarious CPIs

46. 45Other durable goods (0.02)Misc. durable goodsWatches, jewelry, educational books, luggage, telephone equipment. All based on CPIs (market prices)

47. 46Final consumption expenditures of nonprofit institutions serving households (NPISHs) (0.03)NPISH definitionCurrent operating expenditures by nonprofits less sales to households and other sectors. PricesBy construction, essentially everything in NPISHs does not have a market price, so costs of inputs are used for priced outputs. Example: price of 1 hour of a minister’s time = minister’s hourly wage