Archive for July 7th, 2011

Does oil price shock lead to inflation?

July 7, 2011

This short note by St Louis Fed economists says there is no impact on inflation.

Our results suggest that oil prices primarily affect energy prices but not the prices of other components in the CPI. Indeed, our estimation shows that a $1/barrel permanent increase in crude oil can cause an immediate $0.03/gallon permanent increase in gasoline. It is not fully understood, however, why energy prices no longer pass-through to other consumer goods and services as they once did. One possible explanation is that the share of oil (or energy in general) in total production costs has declined significantly since the first two oil shocks in the 1970s, owing to the adoption of energy saving technologies.

Therefore, oil price shocks appear to have only transitory effects on headline inflation and virtually no impact on measures of underlying trend inflation. These empirical findings provide some support for the use of core inflation (or some other measure of trend inflation) over headline inflation for the purpose of guiding monetary policy.

Confusion over headline vs core  continues. St Louis Fed President himself  says core is rotten.

Should EU public policy tilt towards industrial policy?

July 7, 2011

Such title posts raise eyebrows immediately. Should one move towards industrial policy in advanced economies?

This short paper by Phillip Aghion of Harvard and others advocate the same. Their main point is industrial policy is not a necessary bad. If done properly it could be important for Europe in certain areas and help Europe become more competitive.

Industrial policy has a bad name: ‘picking winners’ and thus distorting competition, while exposing government to capture by vested interests. But there are reasons for a rethink. First, climate change: without government intervention to jump-start massive private investment in clean technologies, governments, by default, encourage investment in dirtier technologies. Second, a new post-crisis realism: laissez-faire complacency by many governments has led to mis-investment in the non-tradable sector at the expense of growth-rich tradables. Third, China – and some other emerging economies – are big deployers of growth-enhancing sectoral policies. The challenge for Europe is how it can design and govern sectoral policies that are competition-friendly and thus growth-enhancing.

More generally, the debate should no longer be for or against industrial policy, which is being implemented in any case in one form or another by many countries globally. Rather, the issue should be on how to avoid first order mistakes through proper policy design and governance.

Hmm.. Interesting perspective.

He looks at criticisms of ind. policy. First govt cannot pick winners. Second, it leads to rent seeking and corruption. As per the authors, both are true but there are any benefits as well. They point to a pretty interesting research finding:

On the empirical front, to our knowledge the most convincing study in support of properly
designed industrial policy is by Nunn and Trefler (2010). They measure if tariff protection is
biased in favour of activities and sectors that use more highly skilled workers, and find a significant
positive correlationbetween productivity growth and the ‘skill bias’ of tariff protection.
Moreover, they show that at least 25 percent of the correlation corresponds to a causal effect.
Overall, their analysis suggests that adequately designed (here: skill-intensive) targeting may
actually enhance growth, not only in the sector that is being subsidised, but also the country as a whole.

Tariff protection leads to benefits in some cases. Did I hear that right? Need to check the paper..

They point to further evidence that ind policy and competition policy should be seen as compliments not substitutes.

In particular, we argue for intervention targeted at areas in which competition and innovation play a key role, and for intervention to be governed so that it is both competition and innovation friendly. We consider five channels of sectoral intervention and report on recent research assessing the impact of government policy. Each of these instances can be read as illustrating the existence of knowledge spillovers that are not properly internalised by private firms and sectors.

Five cases are

  • green technologies (absence of govt policy industry might prefer dirty technologies),
  •  insufficient financial development (banks may not lend to innovative new companies),
  • industrial policy works better when decentralised,
  • works better in more competitive sectors,
  • works better when subsidies are less concentrated
What does one think? I just mentioned a nice paper which talks about limiting the role of government. Here we have another thought on actually making it more interventionist.
Interesting times..

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