“inflation dynamics in asia” (in english) derya 2nov2010.pdf · that drive inflation, or...

Department of Economics

Master of Science in International

Banking and Finance Programme

Seminar

Abstract

Although inflation in Asia is still relatively moderate, it has picked up in

some countries and is becoming an important consideration as

policymakers seek to manage their exits from stimulus, and in particular

to normalize policy conditions while guarding against risks to the

recovery. A key input for managing this exit is an assessment of the forces

that drive inflation, or so-called inflation dynamics. This chapter presents

a quantitative analysis of inflation dynamics in Asia and shows how the

nature and origin of inflation pressures differ across economies and have

changed over time. The chapter also discusses more specifically the

inflation drivers in the two largest emerging Asian economies—China and

India.

Biography

D. Filiz Unsal is an economist in the Asia and Pacific Department of the

International Monetary Fund. She received her Ph.D. degree in economics

from University of York (UK) for her dissertation on “Monetary Policy in

New-Keynesian Framework”. Most of her research centers around

monetary economics, international economics and financial economics.

“Inflation Dynamics in Asia” (in English)

Dr. Derya Filiz Unsal

Economist

Asia and Pacific Department

International Monetary Fund

Date: 2 November 2010 (Tuesday)

Time: 5:30 p.m. – 7:00 p.m.

Venue: GEG01, B. Y. Lam Building

ALL ARE WELCOME

Enquiries: 26167164 (Zuei)/ 26167047 (Kit)

Asia-Pacific Regional Economic Outlook Inflation Dynamics in Asia

D. Filiz Unsal

Asia and Pacific Department

Lingnan University November 2, 2010

Plan of the presentation

Motivation, questions and main conclusions

The role of food and energy prices

A general model of inflation in Asia Two important cases: inflation dynamics in

China and India 2

Motivation, questions and main results

3

Motivation: inflationary pressures have emerged in Asia but inflation is still within central banks’ comfort zone

Asia: Core Inflation (Year-on-year percent change)

Asia (excl. Japan): Headline Inflation (Year-on-year percent change)

4

Motivations

-3

0

3

6

9

12

15

2000

:Q1

2000

:Q4

2001

:Q3

2002

:Q2

2003

:Q1

2003

:Q4

2004

:Q3

2005

:Q2

2006

:Q1

2006

:Q4

2007

:Q3

2008

:Q2

2009

:Q1

2009

:Q4

Australia and New Zealand NIEs ASEAN-5 China India (WPI)

2010

:Q2 -3

0

3

6

9

12

15

2000

:Q1

2000

:Q4

2001

:Q3

2002

:Q2

2003

:Q1

2003

:Q4

2004

:Q3

2005

:Q2

2006

:Q1

2006

:Q4

2007

:Q3

2008

:Q2

2009

:Q1

2009

:Q4

Australia and New Zealand NIEs ASEAN-5 China India (WPI)

2010

:Q2

But output gaps are closing fast in EM Asia, and financial conditions remain accommodative

5

Motivations

95

100

105

110

115

120

125

130

2007

:Q1

2008

:Q1

2009

:Q1

2007

:Q1

2008

:Q1

2009

:Q1

2007

:Q1

2008

:Q1

2009

:Q1

Precrisis trend (2000–07) Actual

Japan NIEs ASEAN-4 (excl. Indonesia)

2010

:Q

2010

:Q 2

2010

:Q 2

Asia (excl. Japan): Headline Inflation (Year-on-year percent change)

-4

-2

0

2

4

6

Vie

tnam

Thai

lan

d

New

Zea

lan

d

Ch

ina

Kor

ea

Indi

a

Ph

ilipp

ines

Mal

aysi

a

Japa

n

Indo

nes

ia

Au

stra

lia

December 2009 Current 2002–07 (average)

Taiw

an P

rovi

nce

of C

hina

Asia: Real Policy Rates

(In percent)

6

Key Questions

If growth continues to be robust, and financial conditions still accommodative, is there a risk that inflationary pressures could accelerate in Asia?

What drives Asia’s inflation? Is it driven by commodity

prices (particularly, food and energy)? Is there a role for demand pressures (output gap)? Has the dynamic of inflation in Asia changed over time?

Why have inflation trends been different in China and India?

Questions

Main Results Unexpected changes of commodity prices do matter for

inflation dynamics in Asia—relatively weaker commodity prices may have contributed to contain inflationary pressures in the region, especially in China.

But the contribution of demand factors to Asia inflation has

risen in recent years—the fast return to full capacity utilization brings inflationary pressures/risks. Demand pressures may have contributed to high inflation in India.

Moreover, global commodity prices are increasingly affected

by Asian demand—what was once essentially an external shock, it’s now also a regional one.

7

Main Results

The Role of Food and Energy Prices

8

9

Food and fuel prices matter for Asia’s inflation: They represent a relatively large share of CPI baskets…

EM Asia: Food and Energy Weights in Consumer Price Index Baskets (In percent)


0

10

20

30

40

50

60

70

80

Indi

a

Ph

ilipp

ines

Indo

nes

ia

Thai

lan

d

Ch

ina

Mal

aysi

a

Hon

g K

ong

SAR

Sin

gapo

re

Kor

ea

Food Energy

EM Asia (food, average)

EMs (food, average) EM Asia (energy, average)

EMs (energy, average)

Taiw

an

Pro

vinc

e of

C

hina

…and have large second round effects on generalized inflation in Asia

10

-4.8

-3.2

-1.6

0.0

1.6

3.2

4.8

6.4

8.0

-60

-40

-20

0

20

40

60

80

100

2001

:Q1

2002

:Q2

2003

:Q3

2004

:Q4

2006

:Q1

2007

:Q2

2008

:Q3

2009

:Q4

Global food price inflation (left scale) Global energy price inflation (left scale) Headline inflation (right scale) Core inflation (right scale)

2010

:Q2

Asia (excl. Japan): Inflation and Global Commodity Price Inflation

(Year-on-year, in percent) Estimated coefficients

(1991:Q1-2010:Q2)1 Estimated coefficients

(2001:Q1-2010:Q2)

Output gap

Interaction dummy of output gap

with commodit

y price inflation

Output gap

Interaction dummy of output gap with

commodity price

inflation

Australia 0.15 * 0.04 * 0.29 * 0.24 * China 0.08 * –0.04 0.12 ** –0.03 Hong Kong SAR 0.02 * 0.40 * 0.02 * 0.77 * India 0.37 * 0.31 * 0.78 * 0.93 * Indonesia 0.36 ** 0.10 0.63 * 0.43 * Korea 0.19 ** 0.12 ** 0.23 * 0.13 * Malaysia 0.02 ** 0.02 * 0.02 * 0.08 ** New Zealand 0.29 ** 0.22 ** 0.38 * 0.46 * The Philippines 0.07 * 0.38 * 0.10 * 0.75 Singapore 0.06 * 0.00 0.21 * 0.02 Taiwan Province of China 0.03 * 0.08 * 0.03 * 0.32 * Thailand 0.04 * 0.10 * 0.06 * 0.20 * Average 0.14 0.14 0.24 0.36

Selected Asia: Pass-through from Output Gap to Core Inflation


11

At the same time, demand from Asia matters for commodity prices

Emerging Asia: Metal and Soy Demand (share in world demand, in percent)

United States and Emerging Asia: Oil Demand

(Share of world demand, in percent)

0

10

20

30

40

50

1981

19

83

1985

19

87

1989

19

91

1993

19

95

1997

19

99

2001

20

03

2005

20

07

2009

China and India

Emerging Asia (excl. China and India)

United States

0

5

10

15

20

25

30

35

40

0

10

20

30

40

50

60

1995

19

97

1999

20

01

2003

20

05

2007

20

09

1980

19

82

1984

19

86

1988

19

90

1992

19

94

1996

19

98

2000

20

02

2004

20

06

2008

20

10

China and India (aluminum demand) China and India (copper demand) Emerging Asia (aluminum demand) Emerging Asia (copper demand)

Metal (left scale)

Soy (right scale)

Emerging Asia

China and India


A Model for Inflation Dynamics

12

13

What drives inflation in Asia?

A Global VAR is estimated, in which headline inflation in 12 Asian economies and 21 non Asian economies is explained by supply and demand shocks: Supply factors: change in production costs and

commodity prices Demand factors: changes in monetary variables (money

supply, interest rates and exchange rates) and output gap The model allows to account for the relative role of regional

and global factors.


14

Supply factors explain a large fraction of inflation variation in Asia, particularly in oil intensive economies

Selected Asia: Contribution of Supply Shocks to Inflation Variation1

(In percent)

Selected Asia: Contribution of Commodity Price Shocks to Inflation

and Oil Intensity

0 10 20 30 40 50 60 70 80

Thai

lan

d

Mal

aysi

a

Indi

a

Japa

n

Kor

ea

Ph

ilipp

ines

Sin

gapo

re

Ch

ina

Indo

nes

ia

New

Zea

lan

d

Au

stra

lia

Hon

g K

ong

SAR

Commodity prices Other supply factors

Regional average

1 Generalized forecast error variance decomposition for endogenous changes in prices over 10 quarters.


AUS CHN

IND

IDN

JPN

MYS

NZL

PHL

SGP KOR

THA

0

10

20

30

40

50

60

0 2 4 6 8

Con

trib

utio

n of

com

mod

ity p

rices

to in

flatio

n

(in p

erce

nt)

Oil intensity (Million barrels of oil equivalent

per GDP in billlions of 2005 U.S. dollars)

HK

Among demand factors, monetary shocks play an important role while output gap contribution is limited

15

Selected Asia: Contribution of Aggregate Demand Shocks to Inflation Variation1 (In percent)

0

20

40

60

80

100

Hon

g K

ong

SAR

Indo

nes

ia

Ph

ilipp

ines

Sin

gapo

re

Kor

ea

Au

stra

lia

Ch

ina

New

Zea

lan

d

Japa

n

Indi

a

Mal

aysi

a

Thai

lan

d

Output gap shocks Monetary shocks Exchange rate

Regional average (monetary shocks)


Regional average (output gap shocks)


But inflation dynamics in Asia has changed over time Output gaps have contributed more to inflation changes

16

Change in the Relative Contribution of Shocks between 1986–99 and 2000–101

(In percentage points)

-60

-40

-20

0

20

40

60

Kor

ea

Indo

nes

ia

Japa

n

Thai

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d

Mal

aysi

a

Ph

ilipp

ines

Ch

ina

Hon

g K

ong

SAR

Indi

a

Sin

gapo

re

Au

stra

lia

New

Zea

lan

d

Output gap Supply shocks Monetary policy shocks



This is confirmed by simple correlations and estimates from inflation equations in Asia

17

Asia (excl. Japan): Year-on-Year Inflation and Output Gap

(In percent)

Selected Asia: Pass-through from Output Gap to Core Inflation

-4

-2

0

2

4

6

8

2000

:Q1

2000

:Q4

2001

:Q3

2002

:Q2

2003

:Q1

2003

:Q4

2004

:Q3

2005

:Q2

2006

:Q1

2006

:Q4

2007

:Q3

2008

:Q2

2009

:Q1

2009

:Q4

Headline inflation

Core inflation

Output gap

2010

:Q2

Estimated coefficients (1991:Q1-2010:Q2)1

Estimated coefficients

(2001:Q1-2010:Q2)

Output gap


commodity price

inflation

Output gap


commodity price

inflation

Australia 0.15 * 0.04 * 0.29 * 0.24 * China 0.08 * –0.04 0.12 ** –0.03 Hong Kong SAR 0.02 * 0.40 * 0.02 * 0.77 * India 0.37 * 0.31 * 0.78 * 0.93 * Indonesia 0.36 ** 0.10 0.63 * 0.43 * Korea 0.19 ** 0.12 ** 0.23 * 0.13 * Malaysia 0.02 ** 0.02 * 0.02 * 0.08 ** New Zealand 0.29 ** 0.22 ** 0.38 * 0.46 * The Philippines 0.07 * 0.38 * 0.10 * 0.75 Singapore 0.06 * 0.00 0.21 * 0.02 Taiwan Province of China 0.03 * 0.08 * 0.03 * 0.32 * Thailand 0.04 * 0.10 * 0.06 * 0.20 * Average 0.14 0.14 0.24 0.36


In terms of shocks’ geographical origins, the source of Asia’s inflation variations are mainly domestic…

18

Selected Asia: Relative Contributions of Domestic, Regional, and Global Factors to

Inflation Variation1 (In percent)

Selected Asia: Contribution of Domestic Shocks to Inflation and Openness

0

20

40

60

80

100

Ch

ina

New

Zea

lan

d

Hon

g K

ong

SAR

Japa

n

Kor

ea

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re

Indi

a

Au

stra

lia

Ph

ilipp

ines

Indo

nes

ia

Thai

lan

d

Mal

aysi

a

Domestic factors Regional factors Global factors



IDN

MYS

PHL

THA

SGP

CHN

IND KOR JPN

AUS

NZL

0

10

20

30

40

50

60

70

80

90

0.0 1.0 2.0 3.0 4.0 Con

trib

utio

n of

dom

estic

sho

cks

to in

flatio

n (in

per

cent

)

Openness (ratio of exports and imports to GDP in

HK

...but regional factors are also important given the impact of Asia’s demand on world commodity prices

19

Contribution of Regional Demand Factor to Fuel and Food Price Inflation1

(In percent)

45.8 29.0

6.1

8.9

22.1 40.7

17.8 18.4

8.2 3.1

0

20

40

60

80

100

Fuel Food

Rest of the world North America Europe Latin America Asia and Pacific



Two important cases: inflation dynamics in China and India

20

21

Inflation dynamics have been quite different in China and India

Inflation Dynamics in China and India

China: Consumer Price Inflation (CPI) (Year-on-year, in percent)

India: Headline Inflation (WPI) and Inflation Volatility

(In percent)

-5

0

5

10

15

1996

19

97

1998

19

99

2000

20

01

2002

20

03

2004

20

05

2006

20

07

2008

20

09

CPI CPI food CPI nonfood

-2

0

2

4

6

8

10

12

14

Jan

-00

Jul-

00

Jan

-01

Jul-

01

Jan

-02

Jul-

02

Jan

-03

Jul-

03

Jan

-04

Jul-

04

Jan

-05

Jul-

05

Jan

-06

Jul-

06

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

WPI inflation

WPI inflation volatility

In China, cost pressures drive nonfood inflation, while food inflation mainly responds to idiosyncratic shocks

22

China: NKPC—Baseline GMM Estimates with Nonfood Inflation1

Variable Coefficients t-statistic

Constant –0.002 ** -1.81

Foreign price gap 0.31 * 15.74

Expected inflation 0.12 * 2.69

Output gap2 0.02 0.93

Lagged inflation 0.63 * 21.38

R-squared= 0.84, adjusted R-squared = 0.75

1 The sample period is 1996–08. * and ** denote significance at 5 and 10 percent levels, respectively.

2 Output gap is estimated through a growth accounting model.


0

20

40

60

80

100

0 4 8 12 0 4 8 12 0 4 8 12

Foreign output gap Domestic output gap Monetary policy and nominal effective exchange rate Global commodity prices Other prices Own price

Quarters

Food prices Nonfood

prices Producer

prices

China: Variance Decomposition of Inflation

(In percent)

In India, output gap plays a larger role in driving inflation

23

India: NKPC—Baseline GMM Estimates with Core Inflation1

India: NKPC—Open Economy GMM Estimates with Core Inflation1



Output gap 0.98 * 2.28


J-statistic = 0.10 (p-value=0.81), adjusted R-squared = 0.36

1 The sample period is 1996:Q2–2010:Q1. * denotes significance at 5 percent level. Estimated constant is not shown here. Coefficients on lagged and forward inflation are constrained to add up to one.



Output gap 0.50 1.50 Relative commodity price index 0.15 * 3.50


J-statistic = 0.13 (p-value=0.66), adjusted R-squared = 0.35.

1 The sample period is 1996:Q2–2010:Q1. * denotes significance at 5 percent level. Estimated constant is not shown here. Coefficients on lagged and forward inflation are constrained to add up to one.


In both cases, inflation inertia is substantial―food price shocks are persistent and may feed into nonfood prices

24

Response of Nonfood prices to a Unit Food Price Shock

Persistence of Food and Nonfood Inflation by GDP per capita

-2

-1

1

2

1 4 16 64

CPI nonfood CPI food

Infl

atio

n Pe

rsis

tenc

e (

sum

of a

utor

egre

ssiv

e co

effic

ient

s)

GDP per capita (thousands of U.S. dollars at PPP prices, log scale


-0.04

0.00

0.04

0.08

0.12

0.16

1 7 13 19 25 31 37

Cumulative difference Average rich half of sample Average poor half of sample

Months since shock

25

Conclusions and Policy Implications

As demand factors has recently gained importance in driving inflation in Asia, policymakers may need to give increasing priority to managing inflation relative to promoting growth

Further improvements in monetary frameworks (i.e.

greater clarity in policy objectives, more exchange rates flexibility) may help to reduce the level and volatility of Asia’s inflation

As Asia’s influence on global commodity prices has grown

over time, the implications of domestic conditions for global commodity prices may also need to be taken into consideration

“inflation dynamics in asia” (in english) derya 2nov2010.pdf · that drive inflation, or...

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