the role of inflation expectations in the new eu member states student: dorina cobÎscan supervisor:...

The role of inflation expectations in the New EU Member States 

Student: DORINA COBÎSCANSupervisor: PhD. Professor MOISĂ ALTĂR

Bucharest, 2010

THE ACADEMY OF ECONOMIC STUDIES BUCHARESTDOCTORAL SCHOOL OF FINANCE AND BANKING

Topics

• The importance of inflation expectations• Objectives• Quantification of inflation expectations• The VAR model with exogenous variables• Testing rationality• Conclusions

The importance of inflation expectations

• Inflation expectations is one of the most important channels through which monetary policy affects economic activity.

• It is important in process of price formation.

• Quantification of inflation expectations play an important role for a central bank which adopted strategy of inflation targeting. It reflects the credibility of population in the central bank.

• Understanding the nature of inflation expectations help central banks to assure a price stability.

Objectives

To quantify inflation expectations in the New EU Member States (Czech Republic, Hungary, Poland and Romania)

To find out if a chosen distribution function influences the results of inflation expectations

To indentify the relationship between inflation expectation and actual inflation

To identify the nature of inflation expectations in the New EU Member States

Quantification of inflation expectations (1)

• Consumer survey carried out by the European Commission

• Monthly data• Sample size : 1000 respondents for Czech

Republic, Poland, Romania and 1500 respondents for Hungary

• Sample period: 2001 M05 – 2010 M02

Data:

Quantification of inflation expectations (2) Questions 5 and 6 of consumer survey

Question 5: How do you think that consumer prices have developed over the last 12 months? a) risen a lotb) risen moderatelyc) risen slightlyd) stayed about the samee) fallenf) don't know  Question 6: By comparison with the past 12 months, how do you expect that consumer prices 

will develop in the next 12 months? They will… a) increase more rapidlyb) increase at the same ratec) increase at a slower rated) stay about the samee) fallf) don't know 

Quantification of inflation expectations (3)

1. Balance statistics: BS = 1 a+ ½ b∙ ∙ - ½ d-1 e∙ ∙

Romania

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HICP inflation Question 5(BS3P) Question 6 (BS3E)

Czech Republic

-40

-20

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80

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-4

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HICP inflation Question 5(BS3P) Question 6 (BS3E)

Hungary

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12

HICP inflation Question 5(BS3P) Question 6 (BS3E)

Poland

-100

1020304050607080

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-1012345678

HICP inflation Question 5(BS3P) Question 6 (BS3E)

Quantification of inflation expectations (4)

2. Normal distribution – adjusted Carlson-Parkin method

Source: Batchelor, Orr, 1988

Quantification of inflation expectations (5)

Making the the necessary transformations, the following results are obtained:

Quantification of inflation expectations (6)

• Quantification of perceived inflation: (10)

Where Assumptions for estimating moderate inflation:•The average value of actual inflation rate over the whole sample;•The running mean of actual inflation;•A linear interpolation between the average of the first half of the sample and the average of the second half of the sample;

•Respondents do not make systematic errors;•Moderate inflation changes linearly and it is needed to quantify the moderate inflation in order to minimize the sum of the square differences between actual and quantified perceived inflation.

Quantification of inflation expectations (7)

Quantification of inflation expectations and perceived inflation

Czech Republic

-1012345678

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Actual inflation Moderate inflation

Perceived inflation Inflation expectations

Poland

-1012345678

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Actual inflation Moderate inflation

Perceived inflation Inflation expectations

Hungary

0123456789

1011

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Actual inflation Moderate inflation

Perceived inflation Inflation expectations

Romania

0

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Actual inflation Moderate inflation

Perceived inflation Inflation expectations

Quantification of inflation expectations (7)

3. Uniform distribution – adjusted method

The solutions of the equations is as follows:

Source: Lyziak (2003)

Quantification of inflation expectations (7)Quantification of inflation expectations using normal and uniform 

distribution functionCzech Republic

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Actual inflationInflation expectations (normal distribution)Inflation expectations (uniform distribution)

Poland

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Actual inflationInflation expectations (normal distribution)Inflation expectations (uniform distribution)

Hungary

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10111213

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Actual inflationInflation expectations (normal distribution)Inflation expectations (uniform distribution)

Romania

-226

1014182226303438

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Actual inflation

Inflation expectations (normal distribution)Inflation expectations (uniform distribution)

The VAR model with exogenous variables (1)

Data description:The analysis is based on monthly data covering the period 2001M05-2009M9.All time series are monthly and the data are obtained from Eurostat, NBR, NBP, MNB, CNB, INSSE.

The VAR model has following endogenous variables:

CORE denotes HICP excluding unprocessed food and energy components, 2005=100; EXP denotes inflation expectations relative to perceived inflation; GAP is the output gap .The series was determined by applying Hodrick-Prescott Filter to monthly

real GDP series. The monthly data were calculated by interpolating the quarterly seasonally adjusted real GDP data (expressed in national currency) in logarithm through Chow-Lin method using as indicator variable the industrial production;

- and exogenous variables:

OIL is the Brent crude oil price in domestic currency, which is calculated as the price of the oil (in US dollars) multiplied with the monthly average of the exchange rates between national currencies and the US dollars;

PPI_EU is the PPI in the EU-27, 2005=100; FOOD is the producer price index of the domestic food industry, 2005=100; ENERGY is the producer price index of energy sector, 2005=100; I_EUR_3M is EURIBOR 3-month money market rate, %.

The VAR model with exogenous variables (2)

The Augment Dickey-Fuller test results show that all variables are stationary. Note that some of the variables were transformed logarithmically (L) or/and for others the first difference (D) was taken.

According to Schwarz and Hannan-Quinn information criteria, the VAR models includes 1 lag.

The VAR model with exogenous variables (3)

Impulse response function and variance decomposition – the  case of Romania

The VAR model with exogenous variables (4)

Impulse response function and variance decomposition – the  case of Hungary

The VAR model with exogenous variables (5)

Impulse response function and variance decomposition – the  case of Poland

•

The VAR model with exogenous variables (6)

Impulse response function and variance decomposition – the  case of Czech Republic

Testing rationality (1)

• Testing the homogeneity of different demographic groups:

Testing rationality (2)

Conclusions:Obtained results using Carlson-Parkin approach show that:1. Inflation expectations and perceived inflation are correlated

with actual inflation2. However there are some periods of misperception due to

factors like adhering to the EU or global crisis.3. Chosen distribution functions in our studies do not influences

the results of inflation expectations4. VAR models depicts that only in case of Romania and Czech

Republic exists a relationship between inflation expectations and inflation ( expectations influence actual inflation).

5. In case of Hungary and Poland, national banks succeeded to break the link between inflation and inflation expectations

6. In the case of Romania and Hungary, the group of respondents divided by level of education is heterogeneous – expected inflation decrease once the level of education is higher

7. In case of Hungary inflation expectations decrease once the level of income increases – group divided by the level of income is heterogeneous

8. For full sample, only in case of Czech Republic and Poland inflation expectations are rational

Thank you!