Aleksandra Halka

Does domestic output gap matter for inflation in a small open economy

In the paper we have investigated to what extent the behaviour of CPI inflation depends on changes in domestic economic activity in Polish economy which is usually described as a small open economy. We conducted a disaggregated analysis using price indices at the COICOP 4-digit level. We specified a small open economy Phillips curve for individual price indices. Additionally we investigated the exchange rate pass through at COICOP group levels. We found that more than 50 per cent of the categories react to the output gap. According to our expectations the categories which are mostly linked to the output gap are services but also non-durable goods. We identified that only small share of prices of durable and semi-durable goods react to domestic demand which can be explained to some extent by globalization process. We also found that more than one third of the price indices respond to exchange rate movements and/or foreign inflation. The impact of exchange rate is most substantial for durable and semi-durable goods which are to large extent perceived as tradable goods. Finally we aggregated the price indices for items sensitive to domestic economic activity and formed an index which, taking into account uncertainty and substantial lags in calculating output gap, may be used as an alternative measure of domestic inflationary pressure.

Whose Inflation Is It Anyway? Inflation Spillovers Between the Euro Area and Small Open Economies

For the last two years, inflation has been steadily falling across the countries of the European Union, generating mounting deflationary pressures. Recent studies suggest that apart from the global determinants influencing broad inflation measures (e.g., plummeting commodity prices), core inflation components are subject to the rising influence of globalization. Our analysis focuses on two aspects: the percentage of Harmonised Index of Consumer Prices (HICP) components affected by deflation, and the spillovers of headline, core, non-energy goods and services inflation between the euro area and selected small open economies. In order to address the issue of inflation broadness, we calculate the percentages of HICP components whose annual growth rates fall into certain ranges and introduce a simple measure, the discrepancy index, to show the relative strength of deflationary and inflationary groups. To address the problem of quantifying inflation spillovers across the selected economies, we use the Diebold and Yilmaz spillover indices. The results indicate that the share of deflationary groups for most countries has been consistently rising since 2010, with the discrepancy index approximating its all-time lows in the fourth quarter of 2014. Simultaneously we show that the spillover index for non-energy industrial goods and services inflation has recently risen considerably, with the measure for headline inflation remaining elevated and the one for core inflation dropping. The euro area remains a net inflation transmitter in most cases.

How to Define the Consumer Perceived Price Index? An Application to Polish Data

Inflation perceived by consumers may differ from official statistics, particularly due to different baskets of goods and services that lay people and statisticians consider and due to consumer loss aversion to price increases. Such effects, as suggested by the prospect theory, are confirmed in many empirical studies showing that consumers’ perceptions are substantially influenced by prices of frequent purchases and that price increases are perceived more strongly than price reductions. Following those observations, alternative consumer price indices were proposed, such as the out-of-pocket price index (ECB 2003) or the index of perceived inflation (Brachinger 2006, 2008). They proved particularly useful in interpreting a jump of inflation perception in some of the Economic and Monetary Union (EMU) economies after the euro introduction. The role of price changes of frequently bought goods and services in determining consumer opinions on price changes also seems significant in Poland, as revealed especially after its accession to the European Union (EU) in 2004. To assess whether their impact on subjectively perceived price changes is of a systematic nature, in this paper we develop different types of indices of price changes that are likely to influence consumer opinions on observed price developments. Then we evaluate them in terms of their impact on consumer inflation perception, as proxied with survey data, and define on this basis the best-performing index, called the consumer perceived price index (CPPI). The results suggest that Polish consumers observe a relatively wide range of goods and services and that both factors suggested by the prospect theory seem to influence their opinions on the evolution of prices in the past.

How to Define the Consumer Perceived Price Index? The Case of Poland

Inflation perceived by consumers may differ from official statistics particularly due to different baskets of goods and services lay people and statisticians consider and by consumer loss aversion to price increases. Such effects, as suggested by the Prospect Theory, are confirmed in many empirical studies, showing that consumers are substantially influenced by prices of frequent purchases and that price increases are perceived more strongly than price decreases. Following those observations, particularly useful in interpreting a jump of inflation perception in some of the EMU economies after the euro introduction, an alternative price index, i.e. the Index of Perceived Inflation, was proposed by Brachinger (2006) and Brachinger (2008). The role of price changes of frequently bought goods and services in determining consumer opinions on price changes was also significant in Poland, especially after its accession to the EU. To assess whether this effect is of a systematic nature, in this paper we develop different indices of price changes of frequently bought goods and services in Poland, including the Index of Perceived Inflation. Then we evaluate these indices vs. CPI inflation in terms of their impact on consumer inflation perception, as proxied with survey data. The results suggest that Polish consumers observe a relatively wide range of goods and services and that both factors suggested by the Prospect Theory seem to influence their opinions on evolution of prices in the past. Having the measure of perceived inflation – i.e. the Consumer Perceived Price Index (CPPI) – that seems more adequate than current CPI inflation on the one hand and survey-based measures of perceived inflation scaled with respect to the trend of CPI inflation on the other hand, we use it as a scaling factor to derive a probability measure of consumer inflation expectations in Poland. Then we compare forecasting accuracy of this measure with respective results based on the measure of consumer inflation expectations quantified in a standard manner.

Lessons from the Crisis. Did Central Banks Do Their Homework

The outbreak of the global financial crisis triggered changes in thinking about the way monetary policy is conducted, in particular about the desired central banks’ reaction function. However, a change in thinking does not necessarily mean that central banks really implemented these modifications. Therefore, I investigate whether four selected European central banks in small open economies – E‡Cesk´a N´arodn´A± Banka, Magyar Nemzeti Bank, Narodowy Bank Polski and Sveriges Riksbank, have adjusted their reaction function to the new paradigm of how monetary policy should be conducted. To address this problem I use a logit model to see first, how the relative importance of inflation and GDP forecasts in the process of setting interest rates evolved over time, second, how the forecast horizon which central banks take into consideration when setting the interest rate has changed, and finally whether they conduct more accommodative monetary policy. The outcomes indicate that all banks after the Lehman Brother’s collapse became more flexible in the way they conduct monetary policy. In order to maintain the stability of the whole economy they are ready to accept an extended period or greater deviations of inflation from the target, although each one in its own way – through extension of the forecasting horizon, the increase of the GDP’s importance, permanent shift of the monetary policy stance to more accommodative one or a mixture of these factors.

Whose Inflation Is It Anyway? The Inflation Spillovers Between The Euro Area and Small Open Economies

For the last two years inflation has been systematically falling across countries in the European Union and lately it exhibits rising deflationary pressures. Recent studies suggest that apart from global determinants influencing broad inflation measures, e.g. plummeting commodity prices, core inflation components are subjected to the rising influence of globalization. Our analysis focuses on two aspects: the extent of the HICP components infected with deflation and the spillovers of headline, core, non-energy goods as well as services inflation between the euro area and distinguished small open economies. In order to answer the question of inflation broadness we calculate the percentages of HICP components which dynamics fall into certain thresholds and introduce a simple measure - the Discrepancy Index showing the relative strength of deflationary and inflationary groups. To address the problem of quantifying the inflation spillovers across distinguished economies we use the Diebold and Yilmaz (2012) spillover indices. Results indicate that the share of deflationary groups for most countries has been consistently rising since 2010 with the Discrepancy Index approximating its all-time lows in the fourth quarter of 2014. Simultaneously we show that the spillover index for non-energy industrial goods and services inflation has lately risen considerably with the measure for headline inflation remaining elevated and for core inflation dropping. The euro area remains a net inflation transmitter in most cases.