CPI Inflation Research Articles

What is the Globalisation of Inflation?

This paper studies the globalisation of CPI inflation by analysing core, energy and food components, testing for structural breaks in the relationships between domestic inflation and a corresponding country-specific foreign inflation series at the monthly frequency for OECD countries. The iterative methodology employed separates coefficient and variance breaks, while also taking account of outliers. We find that the overall pattern of globalisation in aggregate inflation is largely driven by convergence of the mean levels of the core component from the early 1990s, compatible with the introduction of inflation targeting in many countries of our sample. There is less evidence of increased synchronisation of short-run movements in core than aggregate inflation, but an increased role for short run foreign energy inflation often contributes to the globalisation effect.

Understanding India's Food Inflation: The Role of Demand and Supply Factors

Over the past decade, India has seen a prolonged period of high inflation, to a large extent driven by persistently-high food inflation. This paper investigates the demand and supply factors behind the contribution of relative food inflation to headline CPI inflation. It concludes that in the absence of a stronger food supply growth response, food inflation may exceed non-food inflation by 2 1/2-3 percentage points per year. The sustainability of along-term inflation target of 4 percent under India's recently-adopted flexible inflation targeting framework will depend on enhancing food supply, agricultural market-based pricing, and reducing price distortions. A well-designed cereal buffer stock liquidation policy could also help mitigate food inflation volatility.

Do Inflation Expectations Matter in a Stylised New Keynesian Model? The Case of Poland

This paper estimates different versions of a stylised New Keynesian model of the Polish economy, in which alternative measures of inflation expectations are used. They include: model-based (rational) expectations as well as survey measures of inflation expectations formed by consumers, enterprises and financial sector analysts. After estimating the models we verify to what extent the use of different measures of inflation expectations affects the assessment of the monetary transmission mechanism, the exchange rate pass-through and the sacrifice ratio. Simulation results show different responses in all the analysed areas. For example, the maximum reaction of CPI inflation to the interest rate impulse is almost twice bigger if the direct measures of financial sector analysts are used instead of model-consistent expectations. Also the model with survey-based measures of producer inflation expectations displays stronger response of inflation to monetary policy impulse than the model, in which rational expectations are assumed. Estimates of the exchange rate pass-through from the models with survey-based expectations are very similar to each other, but stronger than in the model with rational expectations. The sacrifice ratio seems similar in the case of all versions of the New Keynesian model except its version with consumer inflation expectations that shows significantly larger output loss resulting from a permanent reduction of the inflation target than the other models. Differences in the assessment how monetary factors affect macroeconomic variables, particularly inflation, pose the question which model should be treated as the most adequate. To answer this question we run in-sample simulations, calculating inflation forecasting errors of all the models under consideration. We conclude that the model that assumes rational inflation expectations displays the lowest forecasting accuracy, while the model using inflation expectations of enterprises is the best-performing model. It suggests that the assumption of rational inflation expectations does not match the actual data well. Inflation expectations of Polish enterprises seem the most relevant from the macroeconomic point of view – more relevant than inflation expectations of consumers and financial sector analysts.

Financial openness, the financial accelerator and sectoral dynamics

This paper studies the role of financial openness and the financial accelerator in the sectoral dynamics generated in a small open economy following capital inflow. The results show that where the financial accelerator exists, capital inflow in response to a foreign interest rate shock ultimately results in intersectoral resource transfer that is favorable to the nontradable sector under different monetary policies; the magnitude of the expansion in the nontradable sector being greater under a higher degree of financial openness. The study also finds that, in comparison to CPI inflation targeting, nontradable inflation targeting is better at mitigating resource transfers toward production of nontradables, and at reducing and stabilizing both nontradable inflation and CPI inflation. Furthermore, the findings suggest that the financial accelerator mechanism matters for the effectiveness of monetary policy in addressing dynamics pertinent to the Dutch disease phenomenon, such that CPI inflation targeting is only effective in such a scenario where the financial accelerator is non-existent, and that nontradable inflation targeting operates more effectively in the absence of the financial accelerator as well.

Chinese liquidity increases and the U.S. economy

China has been a major contributor to increased global liquidity over the past twenty years, with increases in liquidity being associated with increases in the price of most assets including commodity prices. This paper investigates the influence of liquidity shocks in China on the U.S. economy. The influence on the U.S. is through China's influence on demand for imports, particularly that of commodities. In all models a positive innovation in China's liquidity is associated with: 1) a positive and statistically significant effect on oil and commodity prices that builds up rapidly over three months and then persists for twenty months; 2) a positive and statistically significant effect on U.S. CPI inflation that builds up over about six months or so and then persists; and 3) a statistically significant depreciation of the real trade-weighted U.S. currency after about two or three months that achieves maximum absolute value after five to eight months and that then persists.

Financial frictions in Latvia

This paper builds a dynamic stochastic general equilibrium (DSGE) model for Latvia that would be suitable for policy analysis and forecasting purposes at Bank of Latvia. For that purpose, I adapt the DSGE model with financial frictions of Christiano et al. (J Econ Dyn Control 35:1999–2041, 2011. doi: 10.1016/j.jedc.2011.09.005 ) to Latvia’s data, estimate it, and study whether adding the financial frictions block to an otherwise identical (‘baseline’) model is an improvement with respect to several dimensions. The main findings are: (1) The addition of the financial frictions block provides more appealing interpretation for the drivers of economic activity and allows to reinterpret their role; (2) financial frictions played an important part in Latvia’s 2008-recession; (3) the financial frictions model beats both the baseline model and the random walk model in forecasting both CPI inflation and GDP.

Structural Changes in Inflation Dynamics: A Bayesian Analysis Allowing for Multiple Breaks at Different Dates for Different Parameters

I make inferences about complicated patterns of structural breaks in inflation dynamics. I extend Chib's (1998) approach by allowing multiple parameters such as the unconditional mean, a group of persistence parameters, and/or the residual variance to undergo mutually independent structural breaks at different dates with the different number of breaks. Structural breaks are modeled as abrupt changes to identify potential regime shifts in economic structure such as a long-run inflation target, monetary policy, and price-setting behavior. I consider postwar quarterly U.S. inflation rates based on the CPI and the GDP deflator over the period from 1953:Q1 to 2013:Q4. I find that two inflation measures had distinct structural changes in different parameters as well as at different dates using Bayesian model selection procedures. CPI inflation experienced a dramatic drop in persistence around the early 1980s, but GDP deflator inflation is still persistent. In addition, the residual variance for both inflation measures switched from a low volatility regime to a high volatility regime in the early 1970s, but it returned to another low volatility regime at different dates: the early 1980s for GDP deflator inflation and the early 1990s for CPI inflation. The residual variance for CPI inflation has increased again since the early 2000s, while GDP deflator inflation has remained less volatile. These volatility shifts are confirmed by the empirical results based on the unobserved components model with stochastic volatility. However, I do not find evidence of a structural shift in the unconditional mean. When reviewing the recent literature, considerable controversy exists over the structural break in inflation persistence around the early 1980s but this appears to be dependent on the measures of inflation, as highlighted by the empirical findings in this paper.

The Informational Content of Market-Based Measures of Inflation Expectations Derived from Government Bonds and Inflation Swaps in the United Kingdom

Market-based measures of inflation expectations can be derived either from the difference between yields on nominal and inflation-linked government bonds or from inflation swap rates. These measures are important indicators of the outlook for inflation and are monitored regularly by the United Kingdom’s Monetary Policy Committee (MPC), alongside other measures of inflation expectations such as those based on surveys. However, the market rates we observe are not perfect measures of expected future inflation. Moreover, in the United Kingdom inflation-linked market instruments reference RPI inflation, whereas the MPC’s target is CPI inflation of 2%. To better extract useful information about expectations for CPI inflation, we develop a no-arbitrage term structure model to decompose the forward inflation curve into: measures of CPI inflation expectations; the expected spread between expected RPI and CPI inflation (the RPI/CPI inflation ‘wedge’); and estimates of risk premia. We then further decompose risk premia estimates into inflation risk premia and liquidity risk premia. We show that long-horizon expectations of CPI inflation, as implied by our model, fell in the 1990s after the introduction of inflation targeting and the creation of the MPC and have since remained fairly stable at around 2%. Our model also suggests that the large falls in measures of implied inflation based on index-linked gilts after the financial crisis were to a large extent the result of changes in liquidity premia in inflation-linked gilt prices.

Dynamic Model Averaging and CPI Inflation Forecasts: A Comparison between the Euro Area and the United States

AbstractThe paper forecasts consumer price inflation in the euro area (EA) and in the USA between 1980:Q1 and 2012:Q4 based on a large set of predictors, with dynamic model averaging (DMA) and dynamic model selection (DMS). DMA/DMS allows not solely for coefficients to change over time, but also for changes in the entire forecasting model over time. DMA/DMS provides on average the best inflation forecasts with regard to alternative approaches (such as the random walk). DMS outperforms DMA. These results are robust for different sample periods and for various forecast horizons. The paper highlights common features between the USA and the EA. First, two groups of predictors forecast inflation: temporary fundamentals that have a frequent impact on inflation but only for short time periods; and persistent fundamentals whose switches are less frequent over time. Second, the importance of some variables (particularly international food commodity prices, house prices and oil prices) as predictors for consumer price index inflation increases when such variables experience large shocks. The paper also shows that significant differences prevail in the forecasting models between the USA and the EA. Such differences can be explained by the structure of these respective economies. Copyright © 2015 John Wiley & Sons, Ltd.

The dynamic relationship between core and headline inflation

This paper investigates the dynamic relationship between headline and core inflation across monetary policy regimes for both the Consumer Price Index and Personal Consumption Expenditure deflator. Our work differs from previous work in that we consider a broader set of core inflation measures. Core inflation measures considered include the respective less food and energy inflation rates and the respective weighted median or trimmed mean inflation rates. Our bivariate vector autoregressions reveal that shocks to headline inflation account for a larger fraction of the forecast error variance of most core measures in the pre-1980 samples. This result is broadly consistent with the findings of previous studies that shocks to headline inflation feed back into core inflation during periods when monetary policy is more accommodative. But our examination of this broader set of core measures also reveals important differences across those measures. In particular, shocks to headline inflation have no impact on the trimmed mean CPI inflation rate in both the pre-1980 and post-1984 samples.

(Forecasting CPI Inflation Using Combination of Point Forecast and Density Forecast)

Korean Abstract: 최근 들어 경제전망의 예측 오차를 줄이기 위한 방안으로 예측조합에 의한 전망(forecast combination)과 밀도함수에 의한 전망(density forecast)이 주목받고 있다. 예측조합에 의한 전망은 하나의 모형에 의한 전망이 아니라 다양한 특성을 가진 여러 예측모형들을 조합하여 전망치를 산출함으로써 예측 오차를 줄이는 방법이다. 밀도함수에 의한 전망은 점 예측(point forecast)과 달리 전망치에 대한 확률밀도함수(probability density function)를 제시하는 방법이다.본고에서는 우리나라의 소비자물가 상승률을 대상으로 예측조합 및 밀도함수를 이용하여 전망을 수행하고 그 성과를 분석하였다. 예측조합에 의한 전망의 경우 다양한 모형의 조합에 따른 위험분산효과 등으로 기준모형인 자기회귀모형보다 우월한 예측력을 보였으며, 아울러 더 많은 수의 모형들이 조합될수록 보다 안정적인 예측력을 보였다. 한편 밀도함수에 의한 전망의 경우 소비자물가 상승률 전망의 방향성을 제시해주는 장점이 있었다. 또한 밀도함수 역시 조합을 통해 보다 정확한 물가 상승률 전망을 기대해 볼 수 있다.본고의 연구 결과에 비추어 볼 때 향후 모형들의 조합방법과 모형별 가중치 부여방법에 대한 연구, 혼합주기모형 개발 등이 진전될 경우 예측조합이나 밀도 함수에 의한 소비자물가 상승률 전망의 예측력을 더욱 향상시킬 수 있을 것으로 기대된다.English Abstract: Forecast combinations and density forecast have frequently been found in empirical research to produce better prediction performance on average than methods based on the best single model. Density forecast an estimate of the probability distribution of the possible future values of that variable has received attention in the forecast literature. This paper combines point forecast and density forecast to predict Korean CPI inflation and compares the performance of each forecast with various models including factor models, shrinkage models, and bayesian model averaging. We find that the more models included in point forecast combinations leads to the better performance of the combinations than the benchmark autoregressive model, regardless of the independent performance of a single model. We also find that combinations of more models provide a result robust to sample periods. Density forecasts and their combinations present the direction of future inflation and predictive densities. We expect that forecast combination and density forecast can provide better performance with more disciplines, for example, combining more various models and mixing different frequency data models.

Monetary policy and commodity terms of trade shocks in emerging market economies

Commodity terms of trade shocks have continued to drive macroeconomic fluctuations in most emerging market economies. The volatility and persistence of these shocks have posed great challenges for monetary policy. This study employs a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model to evaluate the optimal monetary policy responses to commodity terms of trade shocks in commodity dependent emerging market economies. The model is calibrated to the South African economy. The study shows that CPI inflation targeting performs relatively better than exchange rate targeting and non-traded inflation targeting both in terms of reducing macroeconomic volatility and reducing the losses of a non-benevolent central bank. However, macroeconomic stabilisation comes at a cost of increased exchange rate volatility. The results suggest that the appropriate response to commodity induced exogenous shocks is to target CPI inflation.

Taxing fossil fuels under speculative storage

Long-term environmental consequences of taxing fossil fuel usage have been extensively studied in the literature. However, these taxes may also impose several short-run macroeconomic policy challenges, the nature of which remains underexplored. This paper investigates the mechanisms through which environmental taxes on fossil fuel usage can affect the main macroeconomic variables in the short-run. We concentrate on a particular mechanism: speculative storage. Formulating and using a dynamic stochastic general equilibrium (DSGE) model, calibrated for the United States, with an explicit storage facility and nominal rigidities, we show that in designing environmental tax policies it is crucial to account for the fact that fossil fuel prices are subject to speculation. The existence of forward-looking speculators in the model improves the effectiveness of tax policies in reducing fossil fuel usage. Improved policy effectiveness, however, is costly: it drives inflation and interest rates up, while impeding output. Based on this tradeoff, we seek an answer to the question how monetary policy should interact with environmental tax policies in our DSGE model of fossil fuel storage. We show that, in an environment with no speculative storers, monetary policy should respond to output along with CPI inflation in order to minimize the welfare losses brought by taxes. However, when the storage facility is activated, responding to output in the monetary policy rule becomes less desirable.

Core inflation indicators for Saudi Arabia

This paper constructs and analyzes core inflation indicators for Saudi Arabia for the period of March 2012 to May 2014 using two alternative approaches: the exclusion method (ex food and housing/rent) and the statistical method. The findings of the analysis suggest that the ex food and housing/ rent inflation is more volatile than the overall CPI inflation over the sample period. In contrast, the statistical core inflation is relatively more stable and less volatile. Moreover, the ex food and housing/rent inflation is only weakly correlated with headline inflation, whereas the statistical core inflation exhibits a stronger correlation. This combination of lower volatility and higher correlation with headline inflation makes the statistical method a much better choice for policymakers. From a monetary policy standpoint, using a bundle of core inflation measures, including both properly constructed exclusion and statistical methods, is more desirable, especially when variation across measures is widespread, as is the case in Saudi Arabia.

Do Foreign Direct and Portfolio Investments Affect Long-term Economic Growth in Central and Eastern Europe?

Abstract This paper contributes to the literature which investigates the impact of foreign investment on the host country economic growth. More precisely, we test the effect of the foreign direct investment (FDI) and of the foreign portfolio investment (FPI) on the long-term economic growth in Central and Eastern European (CEE) countries, in a panel framework. For this purpose, we resort to a system-GMM approach, which corrects the endogeneity issues between growth and investment, and we employ a large set of control variables, as the interest rate, the CPI inflation, the unemployment rate, the money in circulation, the exchange rate, the primary energy consumption and the level of education. The analyzed time-span is 2005-2012 and the sample includes 13 CEE countries, namely Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, the Slovak Republic and Slovenia. We find that both direct and portfolio investments exert an influence on the long-term economic growth, when we consider equity and investment funds instruments. Our results show that incentive packages should be oriented toward both types of investments. These findings are documented both in the case of inwards and outwards investments.

Business Tendency Surveys and Macroeconomic Fluctuations

We investigate the information content of business tendency surveys for key macroeconomic variables in Switzerland. To summarise the information of a large data set of sectoral business tendency surveys we extract a small number of common factors by a principal components estimator. The estimator is able to deal with mixed-frequency data and missing observations at the beginning and end of the sample period. We show that these survey-based factors explain a relevant share of the movements of key macroeconomic variables, i.e., CPI inflation, GDP, employment, and an output gap. In particular, questions about the current and future expected situation are informative. However, backward-looking questions, for example questions about the situation compared to the previous year, do not contain additional information. We then examine the economic dimension of the data set. Questions about prices, real activity and capacity constraints contain important information for the corresponding macroeconomic variables. Finally, we estimate a dynamic relationship to produce forecasts for our factors and these key macroeconomic variables. It turns out that the predictive ability of our survey-based factor approach is quite encouraging. In a pseudo out-of-sample exercise, our approach beats relevant benchmarks for forecasting CPI inflation and an output gap and adds information to the benchmark forecasts for GDP and employment.

Optimal Monetary Policy and Exchange Rate in a Small Open Economy with Unemployment

In this paper, we consider a small open economy under the New Keynesian model with unemployment of Galí (2011a, b) to discuss the design of the monetary policy. Our findings can be summarized in three parts. First, even with the existence of unemployment, the optimal policy is to minimize variance of domestic price inflation, wage inflation, and the output gap when both domestic price and wage are sticky. Second, stabilizing unemployment rate is important in reducing the welfare loss incurred by both technology and labor supply shocks. Therefore, introducing the unemployment rate as an another argument into the Taylor-rule type interest rate rule will be welfare-enhancing. Lastly, controlling CPI inflation is the best option when the policy is not allowed to respond to unemployment rate. Once the unemployment rate is controlled, however, stabilizing power of CPI inflation-based Taylor rule is diminished.

Tracking Chinese CPI inflation in real time

With recovery from the global financial crisis in 2009 and 2010, inflation emerged as a concern for many central banks in emerging Asia. We use data observed at mixed frequencies to estimate the movement of Chinese headline inflation within the framework of a state-space model, and then take the estimated indicator to nowcast Chinese CPI inflation. The importance of forward-looking and high-frequency variables in tracking inflation dynamics is highlighted and the policy implications discussed.

Inflation and Market Uncertainty in South Africa

AbstractComparison of the movements in the VIX index, the rand – dollar exchange rate and South African CPI inflation reveals a striking resemblance between them, raising the question as to whether or not there is an empirical relationship among them. The aim of this paper is to determine whether or not changes in market uncertainty, as reflected in the VIX index, influence South African inflation. Given that the VIX index reflects market uncertainty, its impact on the inflation rate may differ between times of heightened uncertainty and normality, thus suggesting the presence of multiple regimes. To cater for this possibility, the analysis first uses the general‐to‐specific procedure (including squared and cubed values of dependent and independent variables) with impulse indicator saturation dummies to look for non‐linear behaviour in the form of statistically significant squared and cubed variables and clustered periods of outlier dummies that might reflect an alternative regime. Finding such periods, the analysis next uses a Markov‐switching model to model this non‐linear behaviour explicitly. The results show that market volatility as measured by the VIX indeed explains South African inflation. Moreover, as shown by the second regime of the Markov‐switching model, when market volatility is elevated, its influence on inflation also increases.

Forecasting inflation using commodity price aggregates

This paper shows that for five small commodity-exporting countries that have adopted inflation targeting monetary policies, world commodity price aggregates have predictive power for their CPI and PPI inflation, particularly once possible structural breaks are taken into account. This conclusion is robust to using either disaggregated or aggregated commodity price indexes (although the former perform better), the currency denomination of the commodity prices, and to using mixed-frequency data. In pseudo out-of-sample forecasting, commodity indexes outperform the random walk and AR(1) processes, although the improvements over the latter are sometimes modest.