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Does domestic output gap matter for inflation in a small open economy?

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Abstract

In the paper we have investigated to what extent the behaviour of CPI inflation depends on changes in domestic economic activity in Polish economy which is usually described as a small open economy. We conducted a disaggregated analysis using price indices at the COICOP 4-digit level. We specified a small open economy Phillips curve for individual price indices. Additionally we investigated the exchange rate pass through at COICOP group levels. We found that more than 50 per cent of the categories react to the output gap. According to our expectations the categories which are mostly linked to the output gap are services but also non-durable goods. We identified that only small share of prices of durable and semi-durable goods react to domestic demand which can be explained to some extent by globalization process. We also found that more than one third of the price indices respond to exchange rate movements and/or foreign inflation. The impact of exchange rate is most substantial for durable and semi-durable goods which are to large extent perceived as tradable goods. Finally we aggregated the price indices for items sensitive to domestic economic activity and formed an index which, taking into account uncertainty and substantial lags in calculating output gap, may be used as an alternative measure of domestic inflationary pressure.

Suggested Citation

  • Aleksandra Hałka & Jacek Kotłowski, 2013. "Does domestic output gap matter for inflation in a small open economy?," NBP Working Papers 152, Narodowy Bank Polski, Economic Research Department.
  • Handle: RePEc:nbp:nbpmis:152
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    Cited by:

    1. Oguz Atuk & Cem Aysoy & Mustafa Utku Ozmen & Cagri Sarikaya, 2014. "Turkiye’de Enflasyonun Is Cevrimlerine Duyarliligi : Cikti Acigina Duyarli TUFE Alt Gruplarinin Saptanmasi," Working Papers 1437, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    2. repec:prg:jnlpep:v:preprint:id:640:p:1-18 is not listed on IDEAS
    3. Aleksandra Halka & Grzegorz Szafrański, 2014. "What common factors are driving inflation in CEE countries?," EcoMod2014 6977, EcoMod.

    More about this item

    Keywords

    Inflation; monetary policy; Phillips curve; dissagregated price indices; output gap; exchange rate pass-through;

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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