Response to a comment by

Response to a comment by Waltraud Schelkle on my Fed2 post

My argument does not depend on there being a structural break in the relationship between headline inflation and the difference between non-core and core inflation – that is a break since about 2002 in the relationship shown in Chart 2 of the Fed2 post. It is rather about a break in the time-series process governing the relative price of non-core and core goods – to be precise, greater persistence, since about 2002, in the difference between the inflation rates of non-core and core goods. The fact that headline inflation tends to be higher when non-core inflation exceeds core inflation (that is, when the relative price of non-core goods is rising), need not imply any bias towards higher or lower headline inflation over time than would have been the case with a constant relative price of non-core to core goods. There would be no such bias if an increase in the relative price of non-core to core goods one period tended to be followed by a decrease of comparable magnitude during the following period(s). It so happens that the acceleration of globalisation at the beginning of the century has led to a rather long sequence of years in which an increase in the relative price of non-core goods to core goods has been followed by a further increase in the relative price of non-core goods to core goods. While this process of a rising relative price of non-core to core goods will not last forever, it is likely to have ‘legs’ for at least another decade or so (this medium-term pattern will of course be reversed temporarily if there is a cyclical downturn in global demand). So the structural break was in the relative price process of non-core and core goods – in Chart 1, not in Chart 2. Even though it is not essential to my argument, it is interesting to check whether there is visual evidence of a break in Chart 2 as well. Unfortunately, I haven’t figured out yet how to colour the post-2002 observations in Chart 2 differently from the earlier ones, as you suggested. So instead I offer here two Charts (Chart 3 and Chart 4). Chart 3 has the 1987M1 to 2001M12 observations from Chart 2 of the Fed2 post, and Chart 4 has the 2002M1 to 2007M4 observations from Chart 2. It does indeed look as though the relationship has become somewhat stronger (i.e. the curve is steeper in Chart 4 than in Chart 3). That would be icing on my cake, but the cake would be pretty good even without it.
Chart 3
Chart 4

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Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

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