A Dynamic Analysis of Oil Prices and Inflation Model and Method

Abstract

The study examines the impact of oil prices on inflation by applying a threshold model for five (5) ASEAN members, namely Malaysia, Indonesia, Singapore, Thailand and the Philippines. Three (3) indicators for oil price shocks are extracted in conjunction with Mork [23], Lee et al. [22] and Hamilton [13] methods. Consequently, these values are used to delineate the effect of price shock differentials. The pass-through effect is integrated into the threshold equation model. Later, the model is calculated to have an impact on inflation of high and low oil prices. The result is that the oil price shock appears to have a major impact on inflation when prices are in the high regime. This extends to all shock measures. The effective exchange rate and industrial price index (IHP) are classified as the primary determinant of inflation in all sample countries. As such, counter-cyclical monetary policy considerations should remain driven by the emerging downside risks of oil price shocks. It requires a more accommodative monetary environment to offset inflationary pressures on the domestic economy.