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)
The Role of Food and Energy Prices
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
The Role of Food and Energy Prices
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
The Role of Food and Energy Prices
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.
A Model for Inflation Dynamics
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.
A Model for Inflation Dynamics
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)
1 Generalized forecast error variance decomposition for endogenous changes in prices over 10 quarters.
Regional average (output gap shocks)
A Model for Inflation Dynamics
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
lan
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
1 Generalized forecast error variance decomposition for endogenous changes in prices over 10 quarters.
A Model for Inflation Dynamics
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
Interaction dummy of output gap with
commodity 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
A Model for Inflation Dynamics
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
Sin
gapo
re
Indi
a
Au
stra
lia
Ph
ilipp
ines
Indo
nes
ia
Thai
lan
d
Mal
aysi
a
Domestic factors Regional factors Global factors
1 Generalized forecast error variance decomposition for endogenous changes in prices over 10 quarters.
A Model for Inflation Dynamics
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
1 Generalized forecast error variance decomposition for endogenous changes in prices over 10 quarters.
A Model for Inflation Dynamics
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.
Inflation Dynamics in China and India
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
Variable Coefficients t-statistic
Expected inflation 0.25 * 2.08
Output gap 0.98 * 2.28
Lagged inflation 0.75 * 6.34
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.
Variable Coefficients t-statistic
Expected inflation 0.32 * 4.57
Output gap 0.50 1.50 Relative commodity price index 0.15 * 3.50
Lagged inflation 0.68 * 9.51
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.
Inflation Dynamics in China and India
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
Inflation Dynamics in China and India
-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