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DETERMINANTS OF INFLATION IN ROMANIA
Student: COVRIG NICOLAE
Supervisor: Prof. MOISĂ ALTĂR
Determinants of Inflation in Romania
DOFIN, Bucharest, June 20022
The facts ...
0 20 40 60 80 100 120 140 160
1995
1996
1997
1998
1999
2000
2001
%
Romania Poland Hungary Czech Republic Slovakia
Inflation in CEE transition economies (annual percentage change)
Determinants of Inflation in Romania
DOFIN, Bucharest, June 20023
The goals...
• To find out the causes of high and persistent inflation in ROMANIA
• To asses the role of monetary and other economic policies in the disinflation process
Determinants of Inflation in Romania
DOFIN, Bucharest, June 20024
Possible explanations...
• Supply or cost-push pressures» wages» currency depreciation
• Demand-pull factors» monetary expansion to finance fiscal deficits» large nonsterilized capital inflows
• Structural changes or rigidities» price deregulations» relative price changes
Determinants of Inflation in Romania
DOFIN, Bucharest, June 20025
…and answers for Romania case• The most important factors in driving inflation are the relative
price adjustments and the high volatility of inflation
• Nominal exchange rate depreciation and the nominal wage increases remain a source of inflationary pressures due to risk of spill-overs
• The monetary sector of the economy is not an important determinant of inflation
• There is an important inertia component in the inflation evolution
• The inflationary expectations can be cut off only through coherent structural policies
Determinants of Inflation in Romania
DOFIN, Bucharest, June 20026
ModellingApproach
MONEY MARKET LABOUR MARKET
FOREIGN EXCHANGE MARKET
Deviation from long-run equilibriumDeviation from long-run equilibrium(lagged one period)(lagged one period)
VAR MODEL
Short term dynamics of endogenous variables
RELATIVE PRICE ADJUSTMENTS
ADMINISTRATIVE DECISIONS ABOUT
PRICES
Exogenous variables
Cointegration analysis (in level of variables)
Sample: 1996:01 – 2002:02
Frequency: monthly
Determinants of Inflation in Romania
DOFIN, Bucharest, June 20027
LONG RUN EQUILIBRIUM ON THE MONEY MARKETTheoretical consideration (Ericsson 1998)
),( RYfPM d
oro
iriy
d rrypm
Where:
m - nominal money demand (in log)
y - scale variable, GDP for instance (in log)
ir0y
- rate of return on money itself (expressed in level)
or - rate of return on assets outside of money (expressed in level)
0ri
0ro
0 - rate of inflation
Determinants of Inflation in Romania
DOFIN, Bucharest, June 20028
LONG RUN EQUILIBRIUM ON THE MONEY MARKETChoice of variables for Romania case (1/8)
8.90
9.00
9.10
9.20
9.30
9.40
9.50
9.60
9.70
Jan-
96
Jan-
97
Jan-
98
Jan-
99
Jan-
00
Jan-
01
Jan-
02
9.25
9.75
10.25
10.75
11.25
11.75
12.25LM2XR (left scale)LM2XRsa (left scale)LM2X (right scale)
8.8
9.0
9.2
9.4
9.6
9.8
10.0
Jan-
96
Jan-
97
Jan-
98
Jan-
99
Jan-
00
Jan-
01
Jan-
02
LM2R LM2XR
0%
20%
40%
60%
80%
100%
Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02
Residents’ deposits inforeign currencies
Household savings,time, and restricteddeposits
M1R (Currency outsidebanks, and demanddeposits)
Monthly observation for M2XR where
M2XR = M2R – resident’s foreign
currency deposits
M2XR is I(1)Seasonally adjusted time series was use
Determinants of Inflation in Romania
DOFIN, Bucharest, June 20029
LONG RUN EQUILIBRIUM ON THE MONEY MARKETChoice of variables for Romania case (2/8)
THE CHOICE OF M2XRSA WAS JUSTIFIED BY:
the strong correlation between M1R and M2XR
the intention to capture the monetary substitution
the greater volatility in M2XR
the avoidance of portfolio reallocation due to financial
innovation
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200210
LONG RUN EQUILIBRIUM ON THE MONEY MARKETChoice of variables for Romania case (3/8)
-0.4
-0.3
-0.2
-0.1
0.0
0.1
0.2
0.3
Jan
-96
Jan
-97
Jan
-98
Jan
-99
Jan
-00
Jan
-01
Jan
-02
LY LYsa
As scale variable we use the volume of industrial
production
(seasonally adjusted series)
LYSA ~ I(1) at 99%
To put in evidence the optimal portfolio selection we use:
the nominal deposit rate applied by banks to non-bank customers (% per year)DR ~ I(1) at 99%
The nominal depreciation of ROL against USD is used as proxy for return of deposits in foreign currencies as principal assets outside the M2XR
DLEXUSD ~ I(0) or I(1) taking into account the structural break
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200211
LONG RUN EQUILIBRIUM ON THE MONEY MARKETJohansen cointegration analysis (4/8)
REMARK: DUMMY9703 included – cointegration test possibly affected2 LAGS IN VAR
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200212
LONG RUN EQUILIBRIUM ON THE MONEY MARKETJohansen cointegration analysis (5/8)
8.5340DLEXUSD 0.0096157 -DR 0.030255 YSA 1.28732 XRSALM
LM2XRSA YSA DR DLEXUSD Intercept
Unrestricted cointegrating coefficients for:
-0.28985 0.37313 0.0087696 -0.0027871 2.4736
Normalized cointegrating coefficients for:
-1.0000 1.2873(0.42922)
[-2.99916]
0.030255(0.00430)
[-7.03754]
-.0096157(0.00219)
[ 4.38687]
8.5340(0.17448)
[-48.9117]
Adjustment coefficient for
-0.025066 0.016445 5.244893 -0.95072
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200213
LONG RUN EQUILIBRIUM ON THE MONEY MARKETJohansen cointegration analysis (6/8)
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200214
LONG RUN EQUILIBRIUM ON THE MONEY MARKETStatistics for Johansen cointegration analysis (7/8)
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200215
LONG RUN EQUILIBRIUM ON THE MONEY MARKETError correction term (8/8)
-3
-2
-1
0
1
2
3
1996 1997 1998 1999 2000 2001
Error correction term for long run money demand
The large disequilibria are strongly related to the nominal exchange rate depreciations and to the nominal deposit rate increase
MODELLING APPROACH
20
30
40
50
60
70
80
90
100
1996 1997 1998 1999 2000 2001 2002
DR
-100
0
100
200
300
400
1996 1997 1998 1999 2000 2001 2002
DLEXUSD
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200216
LONG RUN EQUILIBRIUM ON THE LABOUR MARKET Theoretical consideration
LPmPW )1(Real wage W/P is a mark-up over the labour productivity LP
where )1( m and
LP
W
Y
EWP
11
P – level of price E - employment
W – net nominal wage Y - output
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200217
LONG RUN EQUILIBRIUM ON THE LABOUR MARKETVariable evolution
-.4
-.3
-.2
-.1
.0
.1
.2
.3
.4
.5
1996 1997 1998 1999 2000 2001
LWAGR LLP
-.6
-.5
-.4
-.3
-.2
-.1
.0
.1
1996 1997 1998 1999 2000 2001 2002
Real wage mark-up over labour productivity
-.1
.0
.1
.2
.3
.4
.5
.6
1996 1997 1998 1999 2000 2001 2002
Unitary price mark-up over the unitary cost with salaries
ALL VARIABLES ARE I(1)
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200218
LONG RUN EQUILIBRIUM ON THE LABOUR MARKETJohansen cointegration test
REMARK: SEASONAL CENTERED DUMMIES WERE INCLUDED
DUMMYDEC and DUMMYJAN; 10 LAGS IN VAR
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200219
LONG RUN EQUILIBRIUM ON THE LABOUR MARKETJohansen cointegration test
Variable LWAGR LLP LMARKUP Trend Intercept
Normalized adjustment coefficient for:
-0.766830.242304[-3.16475]
-0.211530.25253
[-0.83762]
0.2877760.370434[ 0.77686]
Normalized cointegrating coefficients for:
-1.0000 1.07563-0.08339
[-12.8994]
0.69167-0.05966
[-11.5943]
-0.002221-0.00025
[ 9.05362]
-0.099123
099123.0002221.069167.007563.1 TrendLMARKUPLLPLWAGR
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200220
LONG RUN EQUILIBRIUM ON THE LABOUR MARKETAdditional statistics
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200221
LONG RUN EQUILIBRIUM ON THE LABOUR MARKETAdditional statistics
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200222
LONG RUN EQUILIBRIUM ON THE LABOUR MARKET Error correction term (8/8)
-.15
-.10
-.05
.00
.05
.10
.15
.20
1996 1997 1998 1999 2000 2001
Error correction model for long run real wage
MODELLING APPROACH
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200223
RELATIVE PRICE ADJUSTMENTS (1/7)Theoretical considerations
Ball and Mankiw (1995) offer sound justification for including skewness of the distribution of relative price changes as an explanatory variable for inflation
Ball and Mankiw (1994) explain the mechanism through which inflation is influenced by the variance of the shocks
Reasons for asymmetric, relative price adjustments - the cost-recovery hypothesis - relative wages of high-skilled workers may be slow to adjust to equilibrium
- insufficient adjustment of measured prices for quality improvements
- the Balassa-Samuelson effects
assymetric shocks are very important
trend inflation is very important
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200224
RELATIVE PRICE ADJUSTMENTS (2/7)35 classes of goods and services in the CPI structure
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200225
RELATIVE PRICE ADJUSTMENTS (3/7)
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200226
RELATIVE PRICE ADJUSTMENTS (4/7)
Highest price changes between 1997 and 2002
Smallest price changes between 1997 and 2002
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200227
RELATIVE PRICE ADJUSTMENTS (5/7)
0.00
0.05
0.10
0.15
0.20
0.25
0.30
Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02
-6.00
-4.00
-2.00
0.00
2.00
4.00
6.00DLCPI (divided by 100) Weighted skewness (right scale)
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200228
RELATIVE PRICE ADJUSTMENTS (6/7)High skewned distribution
0
5
10
15
20
25
30
0.0 0.2 0.4 0.6 0.8 1.0
Series: November2001Sample 1 35Observations 35
Mean 0.069435Median 0.023400Maximum 1.031220Minimum -0.078870Std. Dev. 0.173898Skewness 5.019484Kurtosis 28.35463
Jarque-Bera 1084.472Probability 0.000000
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200229
RELATIVE PRICE ADJUSTMENTS (7/7)
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02
DLCPI (divided by 100)
Weighted STDV.
MODELLING APROACH
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200230
ADMINISTRATED PRICES
0
50
100
150
200
250
300
Jan-
97
Jul-9
7
Jan-
98
Jul-9
8
Jan-
99
Jul-9
9
Jan-
00
Jul-0
0
Jan-
01
Jul-0
1
Jan-
02
Fuels
Electric energy
CPI
ROL/USD
Twelve month percentage change
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200231
ADMINISTRATED PRICES“Net inflation” (1)
0
4
8
12
16
20
24
0.00 0.05 0.10 0.15 0.20 0.25
Series: DLCPISample 1996:01 2002:02Observations 74
Mean 0.037719Median 0.027615Maximum 0.267734Minimum 0.005982Std. Dev. 0.037640Skewness 3.981103Kurtosis 22.27329
Jarque-Bera 1340.808Probability 0.000000
0
1
2
3
4
5
6
7
8
9
0.01 0.02 0.03 0.04 0.05
Series: Net inflation 1Sample 1 62Observations 62
Mean 0.026315Median 0.024205Maximum 0.049742Minimum 0.005982Std. Dev. 0.011068Skewness 0.358194Kurtosis 2.266330
Jarque-Bera 2.716336Probability 0.257131
)()1,(2),()()1(21)(1
tutiimpactCtiimpactiDDLCPICCtDLCPIt
i
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200232
ADMINISTRATED PRICES “Net inflation” (2)
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200233
Autonomous inflation: 27,99 % per annum
Inflation inertia: 0.19
ADMINISTRATED PRICES “Net inflation” (3)
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200234
ADMINISTRATED PRICES “Net inflation” (4)
0.00
0.05
0.10
0.15
0.20
0.25
0.30
Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02
Headline inflation Net inflation
0
2
4
6
8
10
12
14
16
18
Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02
Net inflation Headline inflation
MODELLING APPROACH
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200235
SHORT RUN DYNAMICS OF INFLATION (1/7)
• Unrestricted vector autoregression with one lag and:
– Endogenous variables :• DLCPI (inflation rate)• DLM2XR (the change in real M2XR)• DLEXUSDR (real depreciation of ROL against USD)
– Exogenous variables:• ECTMONEY(-1) (error correction term for real money)• ECTWAGE (-2) (error correction term for real wages)• WSKEW (weighted skewness of price changes)• WSTDEV (weighted standard deviation of price changes)• DUMMY9605, DUMMY9612, DUMMY9701, DUMMY9905
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200236
SHORT RUN DYNAMICS OF INFLATION (2/7)
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200237
SHORT RUN DYNAMICS OF INFLATION (3/7)
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200238
SHORT RUN DYNAMICS OF INFLATION (4/7)Impulse response function
-.002
.000
.002
.004
.006
.008
.010
1 2 3 4 5 6 7 8 9 10
Response of DLCPI to DLCPI
-.002
.000
.002
.004
.006
.008
.010
1 2 3 4 5 6 7 8 9 10
Response of DLCPI to DLM2XR
-.002
.000
.002
.004
.006
.008
.010
1 2 3 4 5 6 7 8 9 10
Response of DLCPI to DLEXUSDR
Response to Cholesky One S.D. Innovations ± 2 S.E.
-.008
-.004
.000
.004
.008
.012
1 2 3 4 5 6 7 8 9 10
Response of DLCPI to DLCPI
-.008
-.004
.000
.004
.008
.012
1 2 3 4 5 6 7 8 9 10
Response of DLCPI to DLM2XR
-.008
-.004
.000
.004
.008
.012
1 2 3 4 5 6 7 8 9 10
Response of DLCPI to DLEXUSDR
Response to Generalized One S.D. Innovations ± 2 S.E.
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200239
SHORT RUN DYNAMICS OF INFLATION (5/7)Variance decomposition
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200240
SHORT RUN DYNAMICS OF INFLATION (6/7)Parsimonious model
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200241
SHORT RUN DYNAMICS OF INFLATION (7/7)Parsimonious model
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200242
Conclusion and policy implications (1/2)• The most important factors in driving inflation are the relative
price adjustments and the high volatility of inflation• The relative price adjustment process was necessary• large shocks induced in the overall price system by energy
price changes• the persistence of inflation and the relative price adjustment
process increase the variability of inflation
• Nominal exchange rate depreciation generates inflation by:• The price of raw material products imported• The Balassa-Samuelson effect
• The nominal wages increases remain a source of inflationary pressures due to risk of spill-overs
• However, in the next period the real wages evolution will not be an inflationary source
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200243
Conclusion and policy implications (2/2)
• The monetary sector of the economy is not an important determinant of inflation
• The monetary policy has been enough tight during the period analysed
• There is an important inertia component in the inflation evolution
• The role of inflation expectation
• The inflationary expectations can be cut off only through coherent structural policies
Determinants of Inflation in Romania
DOFIN, Bucharest, June 200244
The facts ...
Consumer Price Index (average annual change in %)
1995 1996 1997 1998 1999 2000 20001Romania 32.3 38.8 154.8 59.1 45.9 45.7 34.1
Poland 27.8 19.9 14.9 11.8 7.3 10.1 5.5
Hungary 28.2 23.6 18.3 14.3 10 9.8 9.2
Czech Republic 9.1 8.8 8.5 10.7 2.1 3.9 4.7
Slovakia 9.9 5.8 6.1 6.7 10.6 12 6.5
Bulgaria 62.1 123 1082.9 22.3 0.3 10.1 7.4