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Comovements in monetary policy

Revealing international correlations with FRED

Reporters and Fed watchers in the U.S. usually think about monetary policy in a domestic framework. But because business conditions, including commodity prices, are correlated internationally, central banks tend to move their policy rates up and down together and their inflation and interest rates tend to be correlated. FRED makes it easy to see these international comovements of macro and policy variables.

The first graph shows comovement in inflation rates from 1970 to the present for four economies: the U.S., Japan, the U.K., and the euro area. Inflation rose in the 1970s as central banks failed to combat the effects of commodity price increases on the general price level and inflation expectations became established.

Before the Financial Crisis of 2007-2009, almost all central banks in the developed world implemented monetary policy mainly by buying and selling short-term bonds to influence short-term interest rates or “policy rates.” The second graph shows the comovement in these policy rates from 1970 to the present for the Federal Reserve, the Bank of Japan, and the Bank of England: These central banks first hiked their policy rates in the 1979-1981 period to combat inflation and were then able to reduce those rates in the 1980s after inflation fell.

The second graph also shows that the Federal Reserve, the Bank of England, and the Bank of Japan lowered their short-term interest rates to zero during the Financial Crisis. To maintain price stability and continue to stimulate their economies, they turned to “unconventional” monetary policies that included buying long-term bonds to reduce long-term interest rates.

The value of the assets of central banks is one (albeit imperfect) way of measuring the monetary stimulus of unconventional policy. The third graph shows the assets of four central banks using an index for their values in 2008. The index value, rather than the value in each respective currency, allows a rough but easy comparison of the relative monetary stimulus. Central bank asset holdings have all increased greatly over the past decades. The Federal Reserve and the Bank of England had the first large responses in 2008-2009. The Bank of Japan began to accumulate assets in earnest starting in 2013. And the European Central Bank did likewise starting in 2015.

How these graphs were created: First graph: Search for “consumer price index for all urban consumers,” select the seasonally adjusted monthly version of the appropriate series, and click “Add to Graph.” From the “Edit Graph” panel’s “Add Line” tab, add the monthly versions of the three series “Consumer Price Index of All Items in Japan,” “Consumer Price Index of All Items in the United Kingdom,” and “Harmonized Index of Consumer Prices: All Items for Euro Area (19 Countries).” For each of these four lines, change the units to “Percent Change from Year Ago.” Lastly, change the start date to 1970-01-01.
Second graph: Search for “effective federal funds rate,” select the appropriate monthly series, and click “Add to Graph.” From the “Edit Graph” panel’s “Add Line” tab, add the monthly versions of the two series “Immediate Rates: Less than 24 hours: Central Bank Rates for Japan” and “Bank of England Policy Rate in the United Kingdom.” Lastly, change the start date to 1970-01-01.
Third graph: Search for “All Federal Reserve Banks: Total Assets,” select the appropriate series, and click “Add to Graph.” From the “Edit Graph” panel’s “Add Line” tab, add the three series “Bank of Japan: Total Assets for Japan,” “Total Central Bank Assets for United Kingdom,” and “Central Bank Assets for Euro Area (11-19 Countries).” For each of these four lines, change the units to “Index (Scale value to 100 for chosen date)” and select the date 2008-01-01. Lastly, change the start date to 2004-01-01.

Suggested by Chris Neely.


Replicating the Japanese Phillips Curve

An essential part of the scientific process is to verify results by trying to replicate them. FRED can be helpful in this regard, and we provide a simple example of this today. Gregor Smith published a 2008 study entitled Japan’s Phillips Curve Looks Like Japan, demonstrating that when you draw a scatter plot of the inflation rate minus the unemployment rate of that country for a sample period of January 1980 to August 2005, the resulting graph, commonly called the Phillips Curve, actually looks like a map of Japan. We replicate this result in the graph above, as one can clearly distinguish the large Japanese islands, Tokyo Bay, and various other features. So, yes, we have replicated the original result.

But the replication process is not only about reproducing results. You also want to check how robust they are to various modifications. The obvious modification here is to extend the sample to a more-recent date. We show this below, and it looks like the various islands have merged. With respect to Japan’s geography, this could only have happened if the seas lowered significantly or if new volcanoes emerged in the sea. As we do not believe this has happened in recent years, we must conclude that the original published result is not robust.

How this graph was created: Search for “Japan CPI” and select the monthly series. Then search for and add “Harmonized Unemployment Rate Japan”—again taking the monthly series. Modify the units of the first series to “Percent Change from Year Ago.” Modify the second series by applying the formula -a. Modify the date range of the graph to 1980-01-01 to 2005-08-01 and the graph type to “Scatter.” For the second graph, extend the date range to a more-recent date.

Suggested by Christian Zimmermann.

View on FRED, series used in this post: JPNCPIALLMINMEI, JPNURHARMMDSMEI

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