Decomposing the Rate of Inflation: Price-Setting and Monetary Policy

Lilian Muchimba, Mimoza Shabani, Alexis Stenfors and Jan Toporowski
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Lilian Muchimba: Bank of Zambia
Jan Toporowski: University of Portsmouth

No 2024-04, Working Papers in Economics & Finance from University of Portsmouth, Portsmouth Business School, Economics and Finance Subject Group

Abstract: The paper adopts a TVP-VAR methodology to investigate the dynamics of inflation components for three countries: the UK, the US and Japan from 1993 to 2023. We deconstruct the CPI into components to examine the actual price changes that make up the CPI and the degree to which changes in those prices influence each other. By doing so, we uncover the connectedness and spillovers between domestic inflation components. We find that whilst connectedness of price changes has been moderate over the last three decades it has increased significantly since the CPI started to soar in late 2021, suggesting the existence of a spillover effect among price-setting firms in the economy. Furthermore, our empirical evidence shows that the transmission mechanism across domestic CPI components varies significantly across countries and over time. From a monetary policy perspective, the findings suggest that a signalling process among consumer market producers complements the signalling by central banks in relation to inflation. Lastly, the cross-country variations over time imply that “no size fits all”, thus emphasizing the importance of domestic spillovers.

Keywords: Consumer Prices; Dynamic Connectedness; Inflation; Monetary policy; Signalling; TVP-VAR (search for similar items in EconPapers)
JEL-codes: C81 D43 E31 E52 (search for similar items in EconPapers)
Pages: 33
Date: 2024-05-15
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mon and nep-opm
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