How do oil price changes affect inflation in Central and Eastern European countries? A wavelet-based Markov switching approach

Dejan Živkov,Jasmina Đurašković,Slavica Manić

doi:10.1080/1406099x.2018.1562011

Dejan Živkov, Jasmina Đurašković + Show 1 more

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https://doi.org/10.1080/1406099x.2018.1562011

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Abstract

ABSTRACTThis paper investigates how oil price changes affect consumer price inflation in eleven Central and Eastern European countries. We use a wavelet-based Markov switching approach in order to distinguish between the effects at different time horizons. We find that the transmission of oil price changes to inflation is relatively low in the Central and Eastern European countries as an increase in the oil price of 100% is followed by a rise in inflation of 1–6 percentage points. The strongest impact from rising oil price on inflation is found for the longer time-horizons for most of the countries, which means that the indirect spillover effect is more intensive than the direct one. Also, the results indicate that exchange rate is not a significant factor when oil shocks are transmitted towards inflation, except in the occasions when high depreciation occurs. Slovakia and Bulgaria are the countries which experience the highest and most consistent pass-through effect throughout the observed sample, and this may be due to these countries having some of the highest oil import/GDP ratios.

Highlights

Oil represents one of the most important commodities in the world, and as such has an important and profound effect on the world economy
Oil serves as a major input in the economy, and this paper tries to quantify the impact of Brent oil price changes on the national inflation rates of the eleven Central and Eastern European countries (CEECs)
Various time-horizons are considered because oil shocks can spillover to inflation directly and indirectly, whereby the direct effect comes to the fore for shorter time-horizons, while the indirect effect is manifested for longer ones

Summary

Introduction

Oil represents one of the most important commodities in the world, and as such has an important and profound effect on the world economy. Oil price changes may arise mainly from two sources – i.e. fastgrowing demand due to high global economic growth or declining supply as a result of shortfalls in production. Cashin, Mohaddes, Raissi, and Raissi (2014) found that supplydriven oil price shocks increase production costs, resulting in a rise of inflation. A demand-driven oil price shock leads to a temporary inflation rise. They claimed that the increase in oil prices in the period 2002–2007 was attributed to booming economic activity and a higher demand for oil in emerging economies. Kilian (2009) stated that oil price increases have been caused mainly by a combination of global aggregate demand shocks and precautionary demand shocks, rather than oil supply shocks, as is commonly assumed In the period after 2007, the oil price plunge is associated with supply-side factors, due to the global financial crisis. Kilian (2009) stated that oil price increases have been caused mainly by a combination of global aggregate demand shocks and precautionary demand shocks, rather than oil supply shocks, as is commonly assumed

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