DETERMINANTS OF
INFLATION IN ROMANIA
Student:
COVRIG NICOLAE
Supervisor: Prof. MOISĂ ALTĂR
Determinants of Inflation in Romania
The facts ...
2001
Inflation in CEE transition economies
(annual percentage change)
2000
1999
1998
1997
1996
1995
%
0
20
Romania
40
60
Poland
80
Hungary
100
120
Czech Republic
140
160
Slovakia
2
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
The goals...
• To find out the causes of high and
persistent inflation in ROMANIA
• To asses the role of monetary and other
economic policies in the disinflation
process
3
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
Possible explanations...
• Supply or cost-push pressures
» wages
» currency depreciation
• Demand-pull factors
» monetary expansion to finance fiscal deficits
» large nonsterilized capital inflows
• Structural changes or rigidities
» price deregulations
» relative price changes
4
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
…and answers for Romania case
• The most important factors in driving inflation are the relative
price adjustments and the high volatility of inflation
• Nominal exchange rate depreciation and the nominal wage
increases remain a source of inflationary pressures due to risk
of spill-overs
• The monetary sector of the economy is not an important
determinant of inflation
• There is an important inertia component in the inflation
evolution
• The inflationary expectations can be cut off only through
coherent structural policies
5
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
Modelling
Approach
Cointegration analysis (in level of variables)
MONEY MARKET
LABOUR MARKET
Deviation from long-run equilibrium
(lagged one period)
FOREIGN EXCHANGE
MARKET
Sample:
1996:01 – 2002:02
VAR MODEL
Short term dynamics of endogenous variables
RELATIVE PRICE
ADJUSTMENTS
ADMINISTRATIVE
DECISIONS ABOUT
PRICES
Frequency: monthly
Exogenous variables
DOFIN, Bucharest, June 2002
6
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE MONEY MARKET
Theoretical consideration (Ericsson 1998)
M
P  f (Y , R)
d
m  p     y y   ri r   ro r   
d
i
o
Where:
m
- nominal money demand (in log)
y
ri
- scale variable, GDP for instance (in log)
ro
- rate of return on assets outside of money (expressed in level) ro

- rate of inflation
y  0
- rate of return on money itself (expressed in level)
 ri  0
0
  0
7
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
12.25
LM2XR (left scale)
LM2XRsa (left scale)
LM2X (right scale)
9.60
10.0
11.75
9.8
11.25
9.6
10.75
9.4
10.25
9.2
9.75
9.0
LM2R
LM2XR
Jan-02
9.70
Jan-01
LONG RUN EQUILIBRIUM ON THE MONEY MARKET
Choice of variables for Romania case (1/8)
9.50
9.40
9.30
9.20
9.10
100%
80%
60%
Residents’ deposits in
foreign currencies
Household savings,
time, and restricted
deposits
40%
20%
0%
Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02
DOFIN, Bucharest, June 2002
M1R (Currency outside
banks, and demand
deposits)
Jan-00
Jan-99
Jan-98
8.8
Jan-97
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
9.25
Jan-96
8.90
Jan-96
9.00
Monthly observation for M2XR where
M2XR = M2R – resident’s foreign
currency deposits
Seasonally adjusted time series
was use M2XR is I(1)
8
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE MONEY MARKET
Choice of variables for Romania case (2/8)
THE CHOICE OF M2XRSA WAS JUSTIFIED BY:
the strong correlation between M1R and M2XR
the intention to capture the monetary substitution
the greater volatility in M2XR
the avoidance of portfolio reallocation due to financial
innovation
9
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE MONEY MARKET
Choice of variables for Romania case (3/8)
0.3
LY
LYsa
0.2
0.1
-0.2
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
-0.1
Jan-96
0.0
As scale variable we use the
volume of industrial
production
(seasonally adjusted series)
LYSA ~ I(1) at 99%
-0.3
-0.4
To put in evidence the optimal portfolio selection we use:
the nominal deposit rate applied by banks to non-bank customers (% per year)
DR ~ I(1) at 99%
The nominal depreciation of ROL against USD is used as proxy for return of
deposits in foreign currencies as principal assets outside the M2XR
DLEXUSD ~ I(0) or I(1) taking into account the structural break
10
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE MONEY MARKET
Johansen cointegration analysis (4/8)
REMARK: DUMMY9703 included – cointegration test possibly affected
2 LAGS IN VAR
DOFIN, Bucharest, June 2002
11
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE MONEY MARKET
Johansen cointegration analysis (5/8)
LM 2 XRSA  1.2873 YSA  0.030255 DR - 0.0096157 DLEXUSD  8.5340
LM2XRSA
YSA
DR
DLEXUSD
Intercept
Unrestricted cointegrating
coefficients for:
-0.28985
0.37313 0.0087696
-0.0027871
2.4736
Normalized
cointegrating
coefficients for:
-1.0000
0.030255
(0.42922) (0.00430)
[-2.99916] [-7.03754]
-.0096157
(0.00219)
[ 4.38687]
8.5340
(0.17448)
[-48.9117]
Adjustment
coefficient for
1.2873
-0.025066 0.016445
5.244893
-0.95072
12
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE MONEY MARKET
Johansen cointegration analysis (6/8)
13
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE MONEY MARKET
Statistics for Johansen cointegration analysis (7/8)
14
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE MONEY MARKET
Error correction term (8/8)
100
90
3
80
Error correction term for long run money demand
2
DR
70
60
50
40
30
20
1
1996
0
1997
1998
1999
2000
2001
2002
400
300
DLEXUSD
-1
200
100
-2
0
-3
-100
1996
1997
1998
1999
2000
2001
1996
1997
1998
1999
2000
2001
2002
The large disequilibria are strongly related to the nominal exchange
rate depreciations and to the nominal deposit rate increase
DOFIN, Bucharest, June 2002
MODELLING APPROACH
15
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE LABOUR MARKET
Theoretical consideration
Real wage W/P is a mark-up over the labour productivity LP
W P  (1  m)  LP
where
m   (1   )
and
W E
W
P  1   
 1   
Y
LP
P – level of price
E - employment
W – net nominal wage
Y - output
16
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE LABOUR MARKET
.1
Variable evolution
Real wage mark-up over labour productivity
.5
.0
LWAGR
.4
LLP
-.1
.3
-.2
.2
-.3
.1
-.4
.0
-.5
-.1
-.6
-.2
1996
-.3
.6
-.4
1996
1997
1998
1999
2000
2001
1997
1998
1999
2000
2001
2002
Unitary price mark-up over the unitary cost with salaries
.5
.4
.3
ALL VARIABLES ARE I(1)
.2
.1
.0
-.1
DOFIN, Bucharest, June 2002
1996
1997
1998
1999
2000
2001
2002
17
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE LABOUR MARKET
Johansen cointegration test
REMARK: SEASONAL CENTERED DUMMIES WERE INCLUDED
DUMMYDEC and DUMMYJAN;
DOFIN, Bucharest, June 2002
10 LAGS IN VAR
18
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE LABOUR MARKET
Johansen cointegration test
LWAGR  1.07563  LLP  0.69167  LMARKUP  0.002221 Trend  0.099123
Variable
LWAGR
Normalized adjustment
coefficient for:
-0.76683 -0.21153 0.287776
0.242304 0.25253 0.370434
[-3.16475] [-0.83762] [ 0.77686]
Normalized
cointegrating
coefficients for:
-1.0000
LLP
LMARKUP Trend
1.07563
0.69167 -0.002221
-0.08339 -0.05966 -0.00025
[-12.8994] [-11.5943] [ 9.05362]
Intercept
-0.099123
19
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE LABOUR MARKET
Additional statistics
20
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE LABOUR MARKET
Additional statistics
21
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
LONG RUN EQUILIBRIUM ON THE LABOUR MARKET
Error correction term (8/8)
.20
Error correction model for long run real wage
.15
.10
.05
.00
-.05
-.10
-.15
1996
1997
1998
1999
2000
2001
MODELLING APPROACH
DOFIN, Bucharest, June 2002
22
Determinants of Inflation in Romania
RELATIVE PRICE ADJUSTMENTS (1/7)
Theoretical considerations
Ball and Mankiw (1995) offer sound justification for including skewness
of the distribution of relative price changes as an explanatory
variable for inflation assymetric shocks are very important
Ball and Mankiw (1994) explain the mechanism
through which inflation is influenced by the variance of the shocks
trend inflation is very important
Reasons for asymmetric, relative price adjustments
- the cost-recovery hypothesis
- relative wages of high-skilled workers may be slow to adjust to equilibrium
- insufficient adjustment of measured prices for quality improvements
- the Balassa-Samuelson effects
23
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
RELATIVE PRICE ADJUSTMENTS (2/7)
35 classes of goods and services in the CPI structure
24
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
RELATIVE PRICE ADJUSTMENTS (3/7)
25
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
RELATIVE PRICE ADJUSTMENTS (4/7)
Highest price changes between 1997 and 2002
Smallest price changes between 1997 and 2002
26
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
RELATIVE PRICE ADJUSTMENTS (5/7)
0.30
DLCPI (divided by 100)
Weighted skewness (right scale)
6.00
0.25
4.00
0.20
2.00
0.15
0.00
0.10
-2.00
0.05
-4.00
0.00
-6.00
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
27
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
RELATIVE PRICE ADJUSTMENTS (6/7)
High skewned distribution
30
Series: November2001
Sample 1 35
Observations 35
25
20
15
10
5
0
0.0
0.2
0.4
0.6
0.8
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
0.069435
0.023400
1.031220
-0.078870
0.173898
5.019484
28.35463
Jarque-Bera
Probability
1084.472
0.000000
1.0
28
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
RELATIVE PRICE ADJUSTMENTS (7/7)
1.40
DLCPI (divided by 100)
1.20
Weighted STDV.
1.00
0.80
0.60
0.40
0.20
0.00
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
MODELLING APROACH
DOFIN, Bucharest, June 2002
Jan-02
29
Determinants of Inflation in Romania
ADMINISTRATED PRICES
Twelve month percentage change
300
Fuels
250
Electric energy
CPI
200
ROL/USD
150
100
50
Jan-02
Jul-01
Jan-01
Jul-00
Jan-00
Jul-99
Jan-99
Jul-98
Jan-98
Jul-97
Jan-97
0
30
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
ADMINISTRATED PRICES
“Net inflation” (1)
24
Series: DLCPI
Sample 1996:01 2002:02
Observations 74
20
9
Series: Net inflation 1
Sample 1 62
Observations 62
8
7
16
12
8
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
0.037719
0.027615
0.267734
0.005982
0.037640
3.981103
22.27329
Jarque-Bera
Probability
1340.808
0.000000
6
5
4
3
2
4
0
1
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
0.026315
0.024205
0.049742
0.005982
0.011068
0.358194
2.266330
Jarque-Bera
Probability
2.716336
0.257131
0
0.00
0.05
0.10
0.15
0.20
0.25
0.01
0.02
0.03
0.04
0.05
t
DLCPI( t )  C 1  C 2  DLCPI( 1)   D( i )  impact ( i , t )  C 2  impact ( i , t  1)  u( t )
i 1
31
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
ADMINISTRATED PRICES “Net inflation” (2)
32
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
ADMINISTRATED PRICES “Net inflation” (3)
Autonomous inflation: 27,99 % per annum
Inflation inertia:
DOFIN, Bucharest, June 2002
0.19
33
Determinants of Inflation in Romania
ADMINISTRATED PRICES “Net inflation” (4)
0.30
Headline inflation
Net inflation
0.25
0.20
0.15
0.10
0.05
0.00
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
18
Net inflation
16
Headline inflation
14
12
10
8
6
MODELLING
APPROACH
4
2
0
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
34
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
SHORT RUN DYNAMICS OF INFLATION (1/7)
• Unrestricted vector autoregression with one lag and:
– Endogenous variables :
• DLCPI
(inflation rate)
• DLM2XR
(the change in real M2XR)
• DLEXUSDR (real depreciation of ROL against USD)
– Exogenous variables:
•
•
•
•
•
ECTMONEY(-1) (error correction term for real money)
ECTWAGE (-2) (error correction term for real wages)
WSKEW
(weighted skewness of price changes)
WSTDEV
(weighted standard deviation of price changes)
DUMMY9605, DUMMY9612, DUMMY9701, DUMMY9905
35
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
SHORT RUN DYNAMICS OF INFLATION (2/7)
36
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
SHORT RUN DYNAMICS OF INFLATION (3/7)
37
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
SHORT RUN DYNAMICS OF INFLATION (4/7)
Impulse response function
Response to Cholesky One S.D. Innovations ± 2 S.E.
Response of DLCPI to DLCPI
Response of DLCPI to DLM2XR
Response of DLCPI to DLEXUSDR
.010
.010
.010
.008
.008
.008
.006
.006
.006
.004
.004
.004
.002
.002
.002
.000
.000
.000
-.002
-.002
1
2
3
4
5
6
7
8
9
10
-.002
1
2
3
4
5
6
7
8
9
10
1
2
3
4
5
6
7
8
9
10
Response to Generalized One S.D. Innovations ± 2 S.E.
Response of DLCPI to DLCPI
Response of DLCPI to DLM2XR
Response of DLCPI to DLEXUSDR
.012
.012
.012
.008
.008
.008
.004
.004
.004
.000
.000
.000
-.004
-.004
-.004
-.008
-.008
1
2
3
4
5
6
7
8
9
10
-.008
1
2
3
4
5
6
7
8
9
10
1
2
3
4
5
6
7
8
9
10
38
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
SHORT RUN DYNAMICS OF INFLATION (5/7)
Variance decomposition
39
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
SHORT RUN DYNAMICS OF INFLATION (6/7)
Parsimonious model
40
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
SHORT RUN DYNAMICS OF INFLATION (7/7)
Parsimonious model
41
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
Conclusion and policy implications (1/2)
• The most important factors in driving inflation are the relative
price adjustments and the high volatility of inflation
• The relative price adjustment process was necessary
• large shocks induced in the overall price system by energy
price changes
• the persistence of inflation and the relative price adjustment
process increase the variability of inflation
• Nominal exchange rate depreciation generates inflation by:
• The price of raw material products imported
• The Balassa-Samuelson effect
• The nominal wages increases remain a source of inflationary
pressures due to risk of spill-overs
• However, in the next period the real wages evolution will not be
an inflationary source
42
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
Conclusion and policy implications (2/2)
• The monetary sector of the economy is not an
important determinant of inflation
• The monetary policy has been enough tight during the period
analysed
• There is an important inertia component in the
inflation evolution
• The role of inflation expectation
• The inflationary expectations can be cut off only
through coherent structural policies
43
DOFIN, Bucharest, June 2002
Determinants of Inflation in Romania
The facts ...
Consumer Price Index (average annual change in %)
1995
1996
1997
1998
1999
2000
20001
Romania
32.3
38.8
154.8
59.1
45.9
45.7
34.1
Poland
27.8
19.9
14.9
11.8
7.3
10.1
5.5
Hungary
28.2
23.6
18.3
14.3
10
9.8
9.2
Czech
Republic
9.1
8.8
8.5
10.7
2.1
3.9
4.7
Slovakia
9.9
5.8
6.1
6.7
10.6
12
6.5
Bulgaria
62.1
123
1082.9
22.3
0.3
10.1
7.4
44
DOFIN, Bucharest, June 2002