The cyclical behaviour of prices in New Zealand

Abstract

Recent developments in business cycle theory have led to a renewal of interest in the stylised facts of modern business cycles. One stylised fact of particular of interest is the cyclical behaviour of prices and to date research in this area has yielded some interesting results. Until recently, procyclical prices was commonly regarded as a stylised fact. Prompted by the initial research of Kydland and Prescott (1990), a number of overseas studies have found that prices were predominantly countercyclical in the postwar years. Other longer term studies, such as those by Cooley and Ohanion (1991) and Backus and Kehoe (1992), have found that this postwar behaviour represents a change in the cyclical behaviour of prices compared to the pre-World War II years when prices were predominantly procyclical. This thesis undertakes a thorough investigation of the long term cyclical behaviour of prices in New Zealand using the modern business cycle research methods. One significant finding is that, as has been found for several other countries, the cyclical behaviour of prices in New Zealand changed in the postwar period: the price level changed from being predominantly procyclical in the prewar and interwar periods to being predominantly countercyclical in the postwar period while the rate of change of inflation changed from being predominantly countercyclical in the interwar period to being predominantly procyclical in the postwar period. Several aspects of these results are examined including: (i) whether there have any noticeable shifts in the cyclical behaviour of prices over time within the prewar, interwar and postwar periods; and (ii) whether for the more recent years, there are differences in the cyclical behaviour of prices across production sectors. We find that in fact there have been noticeable shifts in the cyclical behaviour of prices within all three periods. Furthermore the cyclical behaviour of prices varies significantly across sectors. This thesis then examines the applicability of one of a number of explanations for the postwar change in the cyclical behaviour of aggregate prices, that is whether for a given pattern of pricing behaviour in different sectors, changes in the sectoral composition of New Zealand's GDP contributed to the postwar change in the cyclical behaviour of aggregate prices. The sectoral composition of New Zealand's GDP has changed substantially in the postwar period as compared to the interwar period; in particular, the contribution of the service sector increased at the expense of the primary sector. However when combined with an analysis of the cyclical behaviour of primary, manufacturing and service sector prices, evidence to suggest that changes in the sectoral composition of GDP contributed to the postwar change in the cyclical behaviour of aggregate prices is not compelling. This would suggest that other possible causes such as changes in the type of shocks impacting on the different sectors and changes in the pricing behaviour in the postwar period as compared to the interwar period are also potentially important explanations worth investigating.