Inflation - bot.or.th · inflation. Price stability is ... D1 is the dummy to control for the 1%...
Transcript of Inflation - bot.or.th · inflation. Price stability is ... D1 is the dummy to control for the 1%...
“Nothing is more important to the conduct of monetary policy than understanding and predicting inflation. Price stability is our responsibility as central banks--it is how, in the long run, we contribute to society's welfare. Achieving and maintaining price stability will be more efficient and effective the better we understand the causes of inflation and the dynamics of how it evolves. ”
Donald L. Kohn
Governor of the Federal Reserve Board
May 20,2005
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Motivation
• Purpose
• Literature Review
• First Purpose: Decompose Inflation Source
• Second Purpose: Monetary Policy Setting
• Robustness
• Conclusion
Outline
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Purpose
Decompose the sources of inflation in Thailand 1
2 Which kind of shocks are important in explaining
the policy rate movements?
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• Aggressive but
temporary. • Monetary Policy
should not tackle
temporary shocks.
Cost Push •
• More gradual but
more persistent.
• Monetary Policy
can and should
tackle when
necessary.
Demand Pull
• More gradual but
more persistent.
• Monetary Policy
can and should
tackle when
necessary.
Expectations
Literature Review
• Estimated OLS regression
based on the New
Keynesian Phillips Curve.
• Found that supply shocks
and expectations shocks
are the main causes of
inflation.
• Used VAR model with
Cholesky decomposition.
• Decomposed the price
of crude oil into supply,
demand, and oil specific
demand shocks.
Sitthichaiviset,
Khemongkorn, Saikaew (2012)
Bank of Thailand Discussion Paper
Lutz Kilian
(2008) American Economic Review
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Yt = B0 + B1Yt + B2Yt-1 + … + εt
Inflation Source 1
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Reduced VAR :
Step1. Estimate Reduced VAR Step2. Estimate A-1
Step3. Multiply e with A
Error term relationship :
=
X X X X X X X X X
Reduced Structural
A-1
Yt = B0 + B1Yt-1 + … + et
Structural VAR :
Methodology
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Inflation Source (Step1) 1
Variables
• Supply : Oil Index Y1 Dubai, Brent, West Texas Intermediate
• Demand : Private Investment Index (PII) Y2
• Inflation : Consumer Price Index (CPI) Y3
• Yearly growth on monthly data
• April 2001 – January 2014
• Optimal lag by Schwartz and Hannan-Quinn : 3
Yt = A0 + A1Yt-1 + A2Yt-2 + A3Yt-3+ et
Step 1 : Estimate Reduced Form VAR
Re Inflation Source (Step2) 1
Step 2 : Estimate A-1
Changes of oil price Supply shock
Changes in PII that cannot be explained by oil price Demand Shock
Changes in CPI that cannot be explained by oil price and PII Expectations Shock
Supply
Demand
Expect
ations
Oil : ε supply PII : ε supply, ε demand CPI : ε supply, ε demand, ε expectations
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= X 0 0 X X 0 X X X
A-1 Contemporaneous Relationship
Oilt = a + PIIt + CPIt + … + εoil
PIIt = a + Oilt + CPIt + … + εPII CPIt= a + Oilt + PIIt + … + εCPI
PII
CPI
εsupply εdemand
εexpectations Oil
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Inflation Source (Step2) 1
Step 2 : A-1 Intuition
Supply Y1
(Oil Index)
Demand Y2
(PII)
Inflation Y3
(CPI)
Expectations
shocks need
persistence
to affect the
demand
Supply
originates from
the external
economy
Supply originates from
the external economy
Inflation
Expectations
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
-1
-0.5
0
0.5
1
1.5
Inflation Source (Step3) 1
Step 3 : Multiply Reduced
Error With A
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= X 0 0 X X 0 X X X
A X 0 0 X X 0 X X X
Identity A-1
Supply
Variance Decomposition: 52%
• Political factors
in the Middle East
• Increase oil
demand
0
0.2
0.4
0.6
0.8
1
1.2
-1.6
-1.1
-0.6
-0.1
0.4
0.9
1.4
1.9
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Inflation Source (Step3) 1
Demand
Variance Decomposition: 1%
• Global Financial
Crisis Recovery
• Flood
Recovery
Monetary Policy
Which kind of shocks are important in explaining
policy rate movements?
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∆it = α + ∆it-1 + ∆ERt-1 + YGAPt-1 + ∆UNEMPt-1 + D1 + Zt + Zt-1 + Zt-2
• Backward looking
• Yearly change on monthly data, March 2002-January 2014
Feature Supply
Demand
Expectations
*Note: Manufacturing Production Index is used as a proxy for GDP, ER is
Nominal Effective Exchange Rate, D1 is the dummy to control for the 1% drop
in interest rate after the Global Financial Crisis
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• Supply Shocks – Found influence of supply shocks contemporaneously and
after one lag.
– Explanation: Wage-price spiral, changes in characteristics of the supply shocks.
• Demand shocks – No influence of demand shocks on policy rate.
– Explanation: Low contribution of demand shocks to inflation.
• Expectations shocks – Found influence of expectations shocks after one lag.
– Explanation: Inflation targeting needs to anchor expectations.
Monetary Policy Results 2
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• VAR lag length
– Including 6, 8, and 12 lags in VAR yield similar results.
• Proxy for supply shocks
– Using domestic oil price as supply shocks yields similar
results.
• Control variables for monetary policy regression
– Other control variables: Federal Funds Rate, Business Sentiment Index.
Robustness
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Conclusion
• Knowing the source of inflation is critical for inflation
targeting central banks, therefore, this paper aims
to decompose inflation source using a method that
does not put the variables under a construction.
• The main sources of inflation in Thailand are from
supply shocks and inflation expectations shocks.
• Practical policy setting may deviate from the
theories to achieve the optimal solution.
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