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MODEL L ING INFLATION IN CROATIA TANJA BROZ & MARUŠKA VIZEK

MODEL L ING INFLATION IN CROATIA TANJA BROZ & MARUŠKA VIZEK. Structure of the presentation. Motivation for the research Short overview of past inflation behaviour in Croatia Review of related work on modelling inflation Derivation of the long-run sectoral determinants of inflation

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MODEL L ING INFLATION IN CROATIA TANJA BROZ & MARUŠKA VIZEK

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  1. MODELLING INFLATION IN CROATIA TANJA BROZ & MARUŠKA VIZEK

  2. Structure of the presentation • Motivation for the research • Short overview of past inflation behaviour in Croatia • Review of related work on modelling inflation • Derivation of the long-run sectoral determinants of inflation • Derivation of short-run inflation model • Concluding remarks

  3. Motivation for the research • Constructing a structural model of inflation in Croatia • Encompassing all relevant sectors of the economy • Knowing inflation drivers is of the most essential importance for fulfilment of the Maastricht convergence criteria • Previous research obscure

  4. Past inflation behaviour • 1990 – 1993; hyperinflation and recession (1616% yoy) • 1993; introduction of the Stabilization program based on nominal exchange rate anchor • 1994 – today; stable inflation

  5. Related research • Payne (2002) – VAR - wage increase and currency depreciation are positively correlated with inflation rates; despite hyperinflation no evidence of inflation inertia. • Botrić and Cota (2006) – SVAR - terms of trade and balance of payments shocks have the strongest impact on prices; Croatia is a small open economy with high import dependency and uncompetitive economic structure. • Pufnik and Kunovac (2006) - seasonal ARIMA - aggregating CPI component forecasts outperform both the overall CPI and random walk inflation forecasts.

  6. Long-run determinants – Markup (1) • Assuming one cointegrating vector and linear homogeneity, the derived long run markup relationship becomes: • Share of unit labour cost in total unit cost (0.54) seems reasonable since Croatian economy is dominated by service sector. • Large share of import prices in total unit cost is due to high import dependency of Croatian economy.

  7. Long-run determinants – Markup (2) • High correlation with the business cycle

  8. Long-run determinants - Excess money (1) • Cointegrating vector includes M1, CPI, GDP, real estate prices, money market rate, interest rate on foreign exchange deposits and a trend

  9. Long-run determinants - Excess money (2) • Excess money exhibits counter-cyclical properties

  10. Long-run determinants – NEER • By visual inspection only, the presence of B-S effect could not be confirmed. • Hence for short-run inflation function only the first differences of kuna nominal effective exchange rate is used.

  11. Long-run determinants – Excess demand

  12. Inflation function (1) • We regressed Dcpit on • long run solutions – markupt-1, excessmoneyt-1, DNeert-i, and Dgdp_gapt-i, and • short run dynamics Dppit-i, Dtrading_partners_cpit-i, Dm1t-i, Dimport_pricest-i, Dr_forext-i, where i takes 1 to 3

  13. Inflation function (2) • The model passes various diagnostic tests, encompassed the unrestricted general model, variables are statistically significant and have theoretically plausible signs (except nominal effective exchange rate).

  14. Inflation function (3) • Diagnostic features of the inflation model

  15. Inflation function (4) • Recursive Analysis of Inflation Model

  16. Inflation function (5) • Recursively estimated coefficients of the inflation model

  17. Concluding remarks • All long run relationships significantly influence quarter-on-quarter inflation rate. • Markup and excess money, imposed as error correction terms are the most significant variables for explaining the short run behaviour of inflation. • Price and monetary variables are found to be important in explaining inflation variance. • Magnitude of monetary aggregates influence on CPI is marginal. • Pass-through of Croatian trading partners CPI and Croatian PPI on inflation in Croatia are not significant. • Presented diagnostic tests suggest that the model could be used for forecasting purposes.

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