Monetary Policy and the Economy Q1/10

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• Monetary Policy and the Economy Q1/10 (PDF, 1.3 MB) June 2010.

Studies and Analyses

• Recovery of the Global Economy in the Second Half of 2009 (PDF, 515 kB) Orthofer, Schreiner, Vondra. Orthofer, Schreiner, Vondra – Monetary Policy and the Economy Q1/10 The world economy has overcome the cyclical trough. On the back of extensive economic stimulus programs, most economies returned to positive growth rates in the second half of 2009, with emerging countries taking the lead. The rate of the recovery, however, diverges strongly across the different regions. Not only the emerging Asian countries grew at a vigorous pace; the U.S. economy, too, posted healthy quarter-on-quarter growth at a rate last seen six years ago. Yet, recent confidence indicators suggest that economic growth will continue at a slower pace. While the world economic recovery gained momentum in the fourth quarter of 2009, the development of economic activity in the euro area remained below expectations. In comparison with the previous quarter, the economy of the single currency area grew by 0.1% in the fourth quarter of 2009, with growth driven exclusively by the positive contribution of net exports. Euro area domestic demand is unlikely to give growth a genuine boost in the quarters to come. Current forecasts generally point to a gradual recovery of economic activity in the euro area, which will, however, be weaker than the U.S. revival. Euro area HICP inflation returned to positive levels in November 2009. This was due primarily to base effects stemming from commodity prices. The disinflation process of core items, however, is continuing. Given the sluggish recovery in economic activity, the annual core inflation rate fell to a record low of 0.8% in February 2010. The latest forecasts predict that there will be no risks to price stability until the end of 2011. Especially thanks to a slight recovery in international demand, the Central, Eastern and Southeastern (CESEE) EU Member States entered a period of economic stabilization in the second half of 2009, recording – once again – moderately positive average growth rates (on a quarterly basis). However, cyclical developments still vary significantly across the countries of the region. The economic downturn caused current account balances to improve throughout the entire region and brought down inflation rates in several countries. After undergoing the deepest and longest recession in post-war history, Austria registered moderate economic growth in the second half of 2009, supported by the revival of international economic activity, the Austrian government stimulus packages and the inventory cycle. According to recent results of the short-term economic indicator of the Oesterreichische Nationalbank (OeNB), growth is set to remain stable. Real GDP is expected to grow by 0.5% in both the first and the second quarters of 2010 (seasonally and working day adjusted, quarter on quarter). For the entire year 2010 the OeNB expects a real GDP growth rate of about 1½%. en global outlook, euro area, central and (south-)eastern Europe, Austria E2, E3, O1 Jun 30, 2010, 12:00:00 AM

• Shocks, the Crisis and Uncertainty about Future Inflation: Theory and Evidence for the Euro Area (PDF, 806 kB) Gnan, Langthaler, Valderrama. Gnan, Langthaler, Valderrama – Monetary Policy and the Economy Q1/10 This study is motivated by the recent increase in volatility of both inflation and inflation expectations, triggered initially by the surge in commodity prices and more recently by the global economic crisis. While inflation uncertainty rose only moderately in response to the commodity and energy price shock in 2007, the financial and economic crisis triggered a dramatic increase across all types of agents, which was also reflected in historically large forecast errors. During the final months of 2009, both inflation expectations and uncertainty returned to more moderate levels. Uncertainty about future inflation may pose a problem both for monetary policy and for economic efficiency at large. Our study shows that various strands of economic theory offer quite diverse explanations for the mechanisms behind the formation of inflation expectations and the associated uncertainty. Our econometric estimates suggest that behavioral heuristics and information constraints or bounded rationality may indeed influence agents’ uncertainty about future inflation. For instance, both consumers and professional forecasters seem to invest more effort in forming expectations about future inflation if and when inflation developments become more salient. However, in the case of consumers faced with very large inflation shocks, this effect seems to be dampened by other behaviors. In contrast to consumers, professional forecasters’ uncertainty about future inflation reacts to news about the business cycle and monetary policy, which points to their use of a richer data set and more sophisticated models in forming inflation expectations. en inflation expectations, uncertainty, behavioral economics, heterogeneous agents E31, E52, D84, D80 Jun 30, 2010, 12:00:00 AM

• The Relationship between Competition and Inflation (PDF, 592 kB) Janger, Schmidt-Dengler. Janger, Schmidt-Dengler – Monetary Policy and the Economy Q1/10 This study supplements previous empirical work on the relationship between the average rate of inflation and competition by adding a new approach for estimating markups and investigating the annual rate of inflation, price variance and price levels. Subject to certain qualifications, markups can be interpreted as indicators for competition intensity. Our calculation, conducted for 15 countries and 34 sectors, exhibits major differences between the sectors within one country and among the same sectors across various countries. The markups are used to produce estimates of the relationship between competition and inflation (average and annual rates), price levels and price variance. Although a significantly negative correlation with inflation and price variance is evident for the period from 1991 to 2005, competition loses its explanatory power for inflation rates when longer time spans are considered. In terms of economic policy, this study confirms the findings of previous works which identify the intensification of competition as a temporary means of curbing price increases. A new finding from this study is the evidence for the inflation-stabilizing effect of intensified competition, which is caused by its negative correlation with price variance. The fact that no significant relation between price level and competition intensity was found may be attributable to insufficient data. en competition, inflation, markup L11, L16, E31 Jun 30, 2010, 12:00:00 AM

• Determinants of Price Comparison and Supplier Switching Rates in Selected Sectors (PDF, 772 kB) Janger. Janger – Monetary Policy and the Economy Q1/10 This study looks into the factors determining price comparisons and supplier switching as revealed by a representative survey of Austrian consumers. Price comparisons and supplier switching can be interpreted as a measure of the competitive pressure that consumers exert on enterprises. Thereby, they influence the intensity of competition in an industry, which in its turn, curbs inflation and boosts growth. The fundamental driver of switching is the comparison of prices. Those who compare prices not only consider price comparisons but also switching less cumbersome and, hence, switch suppliers more frequently. To a certain extent, search as well as switching costs are perceived to be higher than they actually are, i.e. persons inexperienced in searching and switching suppliers overestimate the difficulties involved. Price comparison behavior is determined by educational attainment (education levels above apprenticeships), gender and (urban or rural) residence. While Internet use is limited for price comparisons, it reduces the efforts required for comparing prices and switching suppliers to a highly significant extent in all sectors. Moreover, search and switching costs play a major role in explaining sectoral differences in price comparison behavior. Therefore, competition intensity could be increased through education reforms, the promotion of Internet usage, sector- specific reductions of search and switching costs as well as awareness-raising measures. The results can be used for further analyses in the field of competition, productivity and inflation. en switching costs, market elasticity, consumer behavior, competition intensity D12, L40 Jun 30, 2010, 12:00:00 AM

• Bank Recapitalization and Restructuring: An Economic Analysis of Various Options (PDF, 544 kB) Elsinger, Summer. Elsinger, Summer – Monetary Policy and the Economy Q1/10 A financial crisis leads to a debt overhang in the banking sector and subsequently to a credit crunch. In most cases, it is not possible to remedy this situation without economic policy measures. In this study, we use a uniform framework to analyze how banks in a crisis situation can be restructured at minimum cost to the taxpayer in order to enable them to function again. We discuss various forms of intervention: measures which do not affect the rights of existing bank owners and creditors (guaranteeing prior debts, purchasing troubled assets, injecting equity) and measures that do (good bank/bad bank, debt-for-equity swap). Measures which minimize the costs to the taxpayer will necessarily affect the rights of existing owners and creditors, meaning that they also raise issues related to the reform of bank insolvency law. en financial crisis, bank recapitalization policy, bank insolvency, financial regulation G01, G2, G28, G33, G38, H0, H2, H81 Jun 30, 2010, 12:00:00 AM

• The Crisis in Financial Innovation (PDF, 361 kB) Eichengreen. Eichengreen – Monetary Policy and the Economy Q1/10 en Jun 30, 2010, 12:00:00 AM