Transmission of Wholesale Price Shocks to Retail Prices
Monetary policy decisions are based on the analysis
of the evolution of variables that determine the
prospective dynamics of the inflation rate. Thus,
central banks try to identify variables that reveal
informational content about the future behavior of
consumer price inflation. By its nature, and based
on empirical evidence, one can say that prices in the
wholesale market are antecedent indicators of the
behavior of retail prices.
Given the importance of the relationship between
retail and wholesale prices, this box follows the
same approach of the one published in the September
2008 Inflation Report and examines the potential
transmission of a shock to the prices at the wholesale
market, synthesized by the Wholesale Price Index
– Internal Availability (IPA-DI), to the consumer
price, synthesized by the Extended Consumer
Price Index (IPCA). In a theoretical perspective, in
principle there would be full transmission (i.e. one
to one), so there would remain only the question of
how much time such transmission would take. In
econometric perspective, the series of price indexes
in the wholesale and retail market would have a
common long term trend, that is, they would be
cointegrated. Considering, however, the significant
difference between the baskets of goods that make
up the IPA and IPCA and also their respective
geographic coverage, it is plausible to assume that
issues about the transmission intensity and the time
period in which it would materialize are both subject
to empirical investigation.
The methodology considered in this box consists
initially in the estimation of Autoregressive Vectors
(VAR), taking into account short-term constraints
(Common Cycle Vectors), as defined in Vahid
and Engle (1993 and 1997) and Issler and Vahid
March 2010
|
Inflation Report
| 113
Table 1 – Shock transmission – Prices
Quarters
IPCA
Free-prices
Tradables
Non-tradables
Transmission of a shock to the IPA-DI
1
0,5
0,5
0,5
0,2
2
0,8
0,8
0,6
0,4
4
0,9
1,0
0,8
0,7
8
1,0
1,0
1,0
1,0
Transmission of a shock to the IPA-Agricultural
1
0,2
0,3
0,3
0,2
2
0,4
0,5
0,4
0,4
4
0,5
0,5
0,5
0,6
8
0,5
0,6
0,6
0,6
Transmission of a shock to the IPA-Industrial
1
0,5
0,5
0,6
0,2
2
0,8
0,8
0,7
0,3
4
1,1
1,1
0,8
0,6
8
1,3
1,3
1,1
1,2
Table 2 – Shock transmission – Time horizons
Months
IPCA
Free-prices
Tradables
Non-tradables
Transmission of a shock to the IPA-DI
1
1,0
1,0
1,4
0,3
2
1,0
1,0
1,0
0,4
4
1,0
0,9
1,0
0,5
8
1,0
0,9
1,2
0,7
Transmission of a shock to the IPA-Agricultural
1
0,5
0,5
0,7
0,3
2
0,6
0,6
0,6
0,4
4
0,6
0,5
0,6
0,4
8
0,5
0,5
0,8
0,4
Transmission of a shock to the IPA-Industrial
1
1,1
0,9
1,5
0,2
2
1,1
0,9
1,1
0,3
4
1,2
1,1
1,1
0,4
8
1,3
1,2
1,3
0,8
(2001), and long-term constraints (Cointegration
Vectors), as defined in Engle and Granger (1987)
and estimated following Johansen (1988). The
sample period includes the first quarter of 1996
until the fourth quarter of 2009. Subsequently, the
generalized impulse response functions for each
VAR are calculated, as suggested in Pesaran and
Shin (1998), by applying a shock of one standard
deviation of the innovation (the error term) of the
wholesale inflation equation.
In the elaboration of Table 1, for each of the sets
of consumer prices, the transmission of a shock
to the IPA-DI after eight quarters was normalized
to one, so that other values should be read as a
fraction of that transmission.1 The main results are:
(i) a major part of the transmission of a wholesale
price shock to retail prices materializes, in general,
by the second quarter; (ii) wholesale price shocks
reach more intensely and quickly the tradable goods
than the non-tradable goods, (iii) a shock to the
IPA-Industrial spreads more intensely and quickly than
a shock to the IPA-Agricultural; and (iv) shocks to the
IPA-Agricultural are not fully completed in
eight quarters while transmission of shocks to
the IPA-Industrial exceed the unit in the same
period. Regarding the time horizon, Table 2
was constructed so that, in each of the analyzed
periods, the transmission of a shock to the IPA-DI
was normalized to the unity. Thus, the remaining
values must be understood as fractions of that
transmission.2 Notice that, in this case, in spite
of conducting the analysis using a different
perspective, the observations (1) to (4) above
remain valid.
To assess the historical evolution of the transmission
for each of the quarters considered and the
robustness of the estimated parameters, Figure 1
was constructed. This graph displays the values
of the transmission of a shock to the IPA-DI to the
IPCA after one, two, four and eight quarters, with
the initial estimation considering the sample that
1/ For example, after eight quarters, the transmission of a one-standard-deviation shock of the innovation of the equation of inflation measured by
the IPA-Industrial to the IPCA is 1.3 times the transmission of a shock of one standard deviation of the innovation of the equation of the inflation
measured by the IPA-DI to the IPCA.
2/ For example, after eight quarters, the transmission of a one-standard-deviation shock of the innovation of the equation of the inflation measured by
the IPA-DI to the non-tradables is 0.7 times the transmission of the same shock to the IPCA.
114 |
Inflation Report
|
March 2010
Figure 1 – Time evolution of the transmission of
the IPA-DI to the IPCA
1.04
1.02
1.00
0.98
0.96
0.94
0.92
0.90
IV
2005
II
2006
IV
II
2007
IV
II
2008
IV
1 quarter
4 quarters
II
2009
IV
2 quarters
8 quarters
Figure 2 – Time evolution of the transmission of the IPA-DI
to the IPCA Moving window of 40 quarters
(%) 1.15
1.05
0.95
0.85
0.75
0.65
IV
2005
II
2006
IV
II
2007
1 quarter
4 quarters
IV
II
2008
IV
II
2009
2 quarters
8 quarters
IV
includes the first quarter of 1996 until the fourth
quarter of 2005 and, from then on, the exercise is
repeated adding a new element to the sample set in
each time until the fourth quarter of 2009. It shows
some stability on the transmission for 2, 4 and
8 quarters, with a slight declining trend since the last
quarter of 2008. The transmission for one quarter
of the IPA-DI to the IPCA has a mild decreasing
trend in its intensity. On the other hand, for Figure 2,
which begins in December 2005, but includes a
moving window of 40 quarters, it shows some
stability in the transmission degree, except for the
period of eight quarters. Reflections of the financial
crisis can be observed through the transmission
instabilities from the fourth quarter of 2008, with
a return to historical patterns more recently. This
behavior is quite different from the one observed
in the 2008 box.
This box intended to analyze the behavior of
consumer prices when shocks impact wholesale
prices. The econometric exercises suggest, in general,
that the transmission of shocks to wholesale prices
to consumer prices occurs in relatively short time
intervals, that the tradable goods are more sensitive
to shocks to wholesale prices than non-tradable goods
and that a shock to industrial prices has greater impact
on consumer prices than a shock to agricultural
prices. These results corroborate those reported for
monthly data in the September 2008 Inflation Report,
showing also an effect of the crisis on the goods
market. Finally, there is no evidence of substantial
changes in the degree of transmission of the IPA-DI
to the IPCA in recent years.
References
ENGLE, R. F.; GRANGER, C. W. J. (1987)
Co-integration and Error Correction: Representation,
Estimation and Testing. Econometrica, 55(2), 251-276.
ISSLER, J. V.; VAHID, F. (2001) Common Cycles
and the Importance of Transitory Shocks to
Macroeconomic Aggregates. Journal of Monetary
Economics, 47(3), 449-475.
March 2010
|
Inflation Report
| 115
JOHANSEN, S. (1988) Statistical Analysis of
Cointegration Vectors. Journal of Economic
Dynamics and Control, 12, 231-254.
PESARAN, H. H.; Shin Y. (1998) Generalized
Impulse Response Analysis in Linear Multivariate
Models. Economic Letters, 58, 17-29.
VAHID, F.; ENGLE, R.F. (1993) Common Trends and
Common Cycles. Journal of Applied Econometrics,
8, 341-360.
VAHID, F.; ENGLE, R. F. (1997) Codependent
Cycles. Journal of Econometrics, 80, 199-121.
116 |
Inflation Report
|
March 2010