Relatives Prices and Inflation in Poland 1989-1997

This paper has been designed as an attempt to estimate the magnitude of the influence of relative price shifts on the overall price level in Poland during the transition period 1989-1997. For that purpose, the theoretical model has been found that builds on menu costs and trend inflation to derive a positive relationship between variance and skewness of the distribution of relative price changes and the general inflation. The model allowed to estimate the effect of relative price shifts within the framework controlling for nominal and real shocks. Using Polish data, a set of three versions of the model were estimated. All of them yielded high explanatory power and statistically significant coefficients on most variance and skewness variables thus giving a strong empirical support to the theoretical relationship. Larger shifts in relative prices accompanying the adjustment process and detected by higher va riance in the equation were proven to exert substantial upward pressure on inflation that persists over time. On the other hand, high positive skewness reflecting the domination of the adjustment process by few large increases was confirmed to produce contemporaneous upward impulse that tends to wear off after one quarter but is stronger in magnitude than that coming from higher variance. Including other explanatory variables like real exchange rate, wages and/or money allowed for observing the relative importance of inflationary factors. The analysis revealed that money and wages remain to be the main factors fueling inflation and can jointly account for almost three quarters of quarterly inflation. If their impact is evaluated separately, wages contribute about one half of inflation and domestic credit almost one third. On the other hand, real exchange rate appreciation was confirmed to significantly lower inflation. The measure based on different paces of inflation between tradables and non-tradables has proven to be a substantial dampening factor with an average elasticity of about minus three quarters.