Volume 13, Issue 4

We investigate the existence and timing of changes in U.S. inflation persistence. To do so, we develop an unobserved components model of inflation with Markov-switching parameters and we measure persistence using impulse response functions based on the model. An important feature of our model is its allowance for multiple regime shifts in parameters related to the size and propagation of shocks. Inflation persistence depends on the configuration of these parameters, although it need not change even if the parameters change. Using the GDP deflator for the sample period of 1959-2006, we find that U.S. inflation underwent two sudden permanent regime shifts, both of which corresponded to changes in persistence. The first regime shift occurred around the collapse of the Bretton Woods system at the beginning of the 1970's and produced an increase in inflation persistence, while the second regime shift occurred immediately after the Volcker disinflation in the early 1980's and produced a decrease in inflation persistence. Meanwhile, consistent with the New Keynesian Phillips Curve, the gap between inflation and its long-run trend displayed little or no persistence throughout the entire sample period.

This paper studies determinants of risk premia using a non-parametric term-structure model of the corporate spread. The model, which measures the extra return of defaultable corporate bonds on their government counterparts, involves the rate of inflation, a key macroeconomic variable that is found to explain the spread non-linearly. This study shows that non-linear methods are useful to investigate features of credit risk and that they give better results than their linear counterparts, enabling testing of affine term-structure specifications. The paper also shows how the non-linear model can be used to forecast the future course of the spread.

Labour market regulations aimed at enhancing job-security are dominant in several OECD countries. These regulations seek to reduce dismissals of workers and fluctuations in employment. The main theoretical contribution is to gauge the effects of such regulations on labour demand across establishment sizes. In order to achieve this, we investigate an optimising model of labour demand under uncertainty through the application of real option theory. We also consider other forms of employment which increase the flexibility of the labour market. In particular, we are modelling the contribution of temporary employment agencies (Zeitarbeit) allowing for quick personnel adjustments in client firms. The calibration results indicate that labour market rigidities may be crucial for understanding sluggishness in firms' labour demand and the emergence and growth of temporary work.

This paper examines the spatial dominance of Korean stock market returns before and after the East Asian financial crisis around 1997. The spatial analysis developed by Park (2006) gives a new tool to test the distributional dominance of one process over the other even under nonstationarity. Extending the notion of well-developed stochastic dominance to the nonstationary time series whose distributions are time-varying, the existence of spatial dominances in Korean stock market returns is investigated. We find the evidence that the cumulative return distributions of Korean stock market index before the crisis spatially dominate the distributions after the crisis in the short term investments, and the dominance gets weaker as the investment period gets longer.

It is widely assumed that, under flexible foreign exchange (FX) rates, countries may pursue an independent monetary policy with respect to domestic goals. By contrast, recent empirical evidence suggests that, similar to pegs, floating regimes are affected by transmissions of nominal quantities such as inflation or nominal interest rates from abroad. For the case of a four dimensional subsystem of the G7, we highlight the strength of international comovements in liquidity adjusted breakeven inflation interpreted as a measure of future inflation prospects. Results indicate that economies with geographical proximity and strong trade linkages (e.g. Canada and the U.S., the UK and EMU) share highest realized correlations of nonstationary breakeven rates. Moreover, these linkages appear strengthened if corresponding exchange rates are relatively stable or if the respective large economy is in a state of relatively uncertain inflation expectations.