regime

Overview of the Study

• Title: A Switching-Regime Model for the Spanish Inflation: 1962-1997

• Authors: Juan Ayuso, Graciela L. Kaminsky, David Lopez-Salido

• Institution: Banco de España - Servicio de Estudios

• Document Type: Working Paper

Purpose and Background

• The paper explores the dynamics of inflation in Spain from 1962 to 1997.

• Highlights significant inflationary periods during the 1970s and early 1980s, transitioning to a stabilization of approximately 2% inflation by 1997.

• Reviews monetary strategies and policy measures employed to combat inflation, including:

  • Austere monetary programs.

  • Joining the European Monetary System (EMS) in 1989.

  • Establishing central bank autonomy in 1994.

  • Introducing inflation targets in January 1995.

Abstract Details

• The research seeks to quantify the impact of various anti-inflation policies on the inflation rate.

• Introduces a switching-regime model to analyze changes in inflation dynamics.

• Emphasizes the ability to identify when Spain switched from one inflation regime to another, linking these shifts to policy implementations.

Introduction (Section 1)

• Discussion of the broader European context, where all economies adopted strict monetary policies post-1970s oil shocks.

• Spain's inflation issues were addressed with various initiatives:

  • Tight monetary policies.

  • Increased independence of central banks.

  • Adoption of inflation targeting in the 1990s.

• The paper's goal: to analyze if the shifting fiscal and monetary policies over decades influenced the stochastic process of inflation.

Chronology of Anti-Inflation Strategies (Section 2)

• Transition to democracy in 1975 led to expansive fiscal policies causing rising inflation.

• Monetary policies, initially accommodative, adjusted in response to inflation:

  • Introduction of the Pactos de La Moncloa in 1977 to break inflation inertia, linking wage settings to expected inflation.

  • Shift to contractionary monetary policy starting in 1978.

  • Inflation significantly declined by 1984 from previously high rates.

• Analysis of how monetary policy evolved:

  • Regulatory changes post- deregulation of the banking industry in 1978.

  • Significant capital inflows post Spain's EU membership leading to challenges in monetary control.

  • Introduction of more stringent anti-inflation measures by the mid-1990s.

Methodology (Section 3)

• Artificial model of inflation established to capture various regimes based on changing fiscal and monetary policies:

  • Inflation modeled as an autoregressive process with regime-dependent characteristics.

  • Markov chain employed to transition between different regimes based on observed inflation values.

  • Implementation of Hamilton's filtering technique to identify and infer regime changes.

Two-Regime Model Estimations (Section 4.1)

• Key findings from the two-regime inflation estimation:

  • Identified significantly different variability and means between high and low inflation states.

  • High volatility associated with elevated inflation.

• Results rejected the null hypothesis of a single inflation regime, indicating regime-switching dynamics are present.

Three-Regime Model and Results (Section 4.2)

• Expansion of the analysis to a three-regime model:

  • Regimes identified as:

    1. High and volatile inflation.

    2. High but stable inflation.

    3. Low and stable inflation.

  • Inflation mean and volatility correlated across regimes, supporting the finding of three distinct states.

• Transition probabilities were observed, although not all changes in mean inflation were found to be statistically significant.

Conclusions (Section 5)

• The paper concludes by reinforcing the idea that Spanish inflation experienced distinct regimes influenced by policy changes during key historical moments:

  • Change in perceived inflation volatility around 1978.

  • Established linkages between lower inflation outcomes and significant policy reforms in the late 1980s and 1990s.

• Discusses implications for forecasting inflation amidst regime shifts, attributing expectation errors to imperfect information rather than agent irrationality.