Whose Inflation Is It Anyway? Inflation Spillovers Between the Euro Area and Small Open Economies

Abstract

For the last two years, inflation has been steadily falling across the countries of the European Union, generating mounting deflationary pressures. Recent studies suggest that apart from the global determinants influencing broad inflation measures (e.g., plummeting commodity prices), core inflation components are subject to the rising influence of globalization. Our analysis focuses on two aspects: the percentage of Harmonised Index of Consumer Prices (HICP) components affected by deflation, and the spillovers of headline, core, non-energy goods and services inflation between the euro area and selected small open economies. In order to address the issue of inflation broadness, we calculate the percentages of HICP components whose annual growth rates fall into certain ranges and introduce a simple measure, the discrepancy index, to show the relative strength of deflationary and inflationary groups. To address the problem of quantifying inflation spillovers across the selected economies, we use the Diebold and Yilmaz spillover indices. The results indicate that the share of deflationary groups for most countries has been consistently rising since 2010, with the discrepancy index approximating its all-time lows in the fourth quarter of 2014. Simultaneously we show that the spillover index for non-energy industrial goods and services inflation has recently risen considerably, with the measure for headline inflation remaining elevated and the one for core inflation dropping. The euro area remains a net inflation transmitter in most cases.

Keywords:

• disaggregation
• euro area
• inflation
• small open economy
• spillovers
• VAR

JEL Classification:

• C32
• C53
• E31
• E37

Notes

1. For each country a few series are not available, like the group “other insurances” for the Czech Republic or Sweden.

2. The highest available disaggregation from the Eurostat. COICOP stands for Classification of Individual Consumption According to Purpose (http://unstats.un.org/unsd/cr/registry/regcst.asp?Cl=5)

3. There is an ongoing debate about whether the target of 2 percent is not too low (Blanchard, Dell’Ariccia, and Mauro 2010). Ball (2014) argues that a 4 percent target is not harmful for the economy and, moreover, minimizes the problem of the zero lower bound policy which we are now facing. However, other authors accept the problem of the zero lower bound (Coibion, Gorodnichenko, and Wieland 2012), but suggest that instead of changing the target, central banks should adopt a different monetary policy—price-level targeting.

4. The results in the rolling-window estimation suggest that the optimal lag structure should equal maximally two suggesting that the use of annual inflation measures does not incorporate the risk of long lag structure of the VAR framework. Moreover, the robustness check reveals that the estimates of the overall spillover index vary insignificantly in response to VAR order changes for different inflation measures.

5. Forecast error variance decomposition is defined as the proportion of the H-step ahead forecast error variance of variable i which is accounted for by the innovations in variable j in the VAR.

6. We are fully aware that such construction cannot be interpreted as a confidence interval. However, the width of the interval suggests the sensitivity to different model specifications, and the inclusion of zero by said quasi-confidence interval indicates that the relation is insignificant in the analyzed period.

7. Almost 50 percent of Swedish imports are from the euro area.

8. By 1 pp in 2010, by 1 pp for the standard rate and 4 pp for the reduced rate in 2012, and in 2013 by 1 pp.

9. The złoty depreciated by 50 percent, whereas the Czech koruna by 25 percent and the Swedish krona by 23 percent.

10. As a remainder, the data for the core measures as well as non-energy industrial goods and services start December 2000. Therefore, the rolling-window analysis is shorter.

Additional information

Notes on contributors

Aleksandra Hałka

Aleksandra Hałka is a Bureau Director at the Narodowy Bank Polski, Warsaw, Poland.Karol Szafranek is an Economist at the Narodowy Bank Polski and a PhD. student at the Warsaw School of Economics, Warsaw, Poland.

Karol Szafranek

Aleksandra Hałka is a Bureau Director at the Narodowy Bank Polski, Warsaw, Poland.Karol Szafranek is an Economist at the Narodowy Bank Polski and a PhD. student at the Warsaw School of Economics, Warsaw, Poland.