Inflation bias and productivity shocks in the transition economies: the case of the Czech Republic

Abstract

This paper examines the reliability of macroeconomic price indices in transition economies, and specifically in the Czech Republic. While methodologically sophisticated price indices in mature market economies may be biased, most policy makers believe that this is only a minor problem and that their price indices accurately describe price and thus real macroeconomic dynamics within their economies. However, some observers have argued that similar methods applied in transition economies have created time series that badly distort real and nominal measures of economic activity. If this were the case, then transition price data have misled both the public and policy makers about the true economic performance during transition and have seriously undermined academic research efforts. We examine the major sources of bias in price indices in a transition economy, specify and estimate a model of price formation and identify systematic and random productivity shocks to both the producer price and consumer price indices (PPI and CPI) in the Czech Republic. Between 1993 and 1998 we find that price index biases have been modest. Therefore, we conclude that Czech macroeconomic policy was not, in general, led astray by biased or distorted statistics.