Evidence for the Explosive Behavior of Food and Energy Prices: Implications in Terms of Inflation Expectations

In this paper, using the recent recursive unit root tests proposed by Phillips et al. (2015), we identify and date-stamp the periods where processed food and energy prices deviate explosively from core inflation and analyze its implications in terms of anchoring inflation expectations. During the period of January 2003-March 2017, we identify existence of three such episodes. Identifying these explosive periods is particularly important, since the evidence reveals that consumers change, i.e., revise their inflation expectations during periods when processed food and energy prices deviate explosively from core inflation. Results indicate that when forming inflation expectations, consumers rely on macroeconomic variables as well as past inflation both in normal and explosive periods. A particularly important policy implication of these findings is that periods of explosive deviations of processed food and energy prices from core inflation should be monitored while designing policies to anchor inflation expectations.