Time-varying Relationship of Price Indexes in Taiwan

Abstract

Price indexes are important variables in macroeconomic models. They are composed to measure various costs in an economy. For instance, a Consumer Price Index (CPI) is constructed to measure the cost of living and a Wholesale Price Index (WPI) summarizes the prices of transactions between enterprises and is intended as a measure of production cost. The price indexes of an economy are highly correlated via economic theory and index composition. The relationship is often treated as stable over time in macroeconomic modeling. In this paper we consider four monthly price indexes of Taiwan, namely the CPI, WPI, Export Price Index (PEX), and Import Price Index (PM). Our goal is to investigate the stability of the relationship between these indexes. We employ various methods, including exponentially weighted recursive least squares and parametric bootstrap methods, to show that, for Taiwan is Economy, the relationship is time-varying for the CPI and WPI. For the export price index (PEX), we found that the relationship is relatively stable after adjusting for the impact of exchange rates between the U.S. Dollar and Japanese Yen versus New Taiwan Dollar. Macroeconomic modelers should be cautioned about the time-varying relationship of price variables, and nonlinear models deserve further investigation.