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Decomposition of the consumer price index into cyclical and acyclical components

Author

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  • Danila Ovechkin

    (Bank of Russia,Russian Federation)

Abstract

The deviation of aggregate demand from its equilibrium level is traditionally considered as an important factor of inflation. However, modern studies increasingly find it difficult to detect a significant connection between the growth of consumer prices and changes in business activity, which raises questions about the efficiency of monetary policy. One of the most effective ways to solve the problem of the missing relationship between inflation and business activity is to study the components of the price index for the heterogeneity of the influence of business activity on the inflation of individual components. Foreign studies show that the Phillips curve, which has become flat in relation to the aggregate price index, stays steep in relation to individual goods and services. This paper examines the influence of business activity on the inflation of components of the CPI in the Russian economy. The decomposition of the CPI into cyclical (sensitive to changes in aggregate demand) and acyclical (determined to a greater extent by other factors) components is carried out on the basis of an estimate of the coefficients of the Phillips curve modified for disaggregated price dynamics. The modified Phillips curve takes into account the change in the monetary policy regime, the impact of the exchange rate and relative prices on the inflation of CPI components, as well as the asymmetric response of the growth of prices of individual goods and services to the shock of the general price level growth. The results obtained confirm the hypothesis of the heterogeneity of the influence of demand on the inflation of individual goods and services in the Russian economy. Cyclical inflation is shown to be much more closely related to business activity than the general price level inflation. The dynamics of cyclical and acyclical inflation in 2021-2024 fully corresponds to the dynamics of aggregate demand. Only the modified Phillips curve made it possible to carry out such a decomposition, the results of which are stable to changes in the proxies for business activity, as well as to the methods of weighting the inflation of the CPI components. The results obtained can be further used in the analysis of price dynamics and the implementation of monetary policy.

Suggested Citation

  • Danila Ovechkin, 2025. "Decomposition of the consumer price index into cyclical and acyclical components," Bank of Russia Working Paper Series wps149, Bank of Russia.
    • Handle: RePEc:bkr:wpaper:wps149
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    References listed on IDEAS

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    1. Jonathon Hazell & Juan Herreño & Emi Nakamura & Jón Steinsson, 2022. "The Slope of the Phillips Curve: Evidence from U.S. States," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 137(3), pages 1299-1344.
    2. James H. Stock & Mark W. Watson, 2020. "Slack and Cyclically Sensitive Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(S2), pages 393-428, December.
    3. Weicheng Lian & Andreas Freitag, 2022. "Inflation Dynamics in Advanced Economies: A Decomposition into Cyclical and Non-Cyclical Factors," IMF Working Papers 2022/091, International Monetary Fund.
    4. Ehrmann, Michael & Ferrucci, Gianluigi & Lenza, Michele & O'Brien, Derry, 2018. "Measures of underlying inflation for the euro area," Economic Bulletin Articles, European Central Bank, vol. 4.
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    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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