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       The role of inflation expectations
in the New EU Member States        
THE ACADEMY OF ECONOMIC STUDIES
BUCHAREST DOCTORAL SCHOOL OF FINANCE AND BANKING

• Student DORINA COBÎSCANSupervisor PhD.
  Professor MOISA ALTAR
• Bucharest, 2010

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Topics

• The importance of inflation expectations
• Objectives
• Quantification of inflation expectations
• The VAR model with exogenous variables
• Testing rationality
• Conclusions

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The importance of inflation expectations

• Inflation expectations is one of the most
  important channels through which monetary policy
  affects economic activity.
• It is important in process of price formation.
• Quantification of inflation expectations play an
  important role for a central bank which adopted
  strategy of inflation targeting. It reflects the
  credibility of population in the central bank.
• Understanding the nature of inflation
  expectations help central banks to assure a price
  stability.

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Objectives

• To quantify inflation expectations in the New EU
  Member States (Czech Republic, Hungary, Poland
  and Romania)
• To find out if a chosen distribution function
  influences the results of inflation expectations
• To indentify the relationship between inflation
  expectation and actual inflation
• To identify the nature of inflation expectations
  in the New EU Member States

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Quantification of inflation expectations (1)
Data

• Consumer survey carried out by the European
  Commission
• Monthly data
• Sample size 1000 respondents for Czech
  Republic, Poland, Romania and 1500 respondents
  for Hungary
• Sample period 2001 M05 2010 M02

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Quantification of inflation expectations (2)

•  Questions 5 and 6 of consumer survey
• Question 5 How do you think that consumer prices
  have developed over the last 12 months?
•  a) risen a lot
• b) risen moderately
• c) risen slightly
• d) stayed about the same
• e) fallen
• f) don't know
•  
•  Question 6 By comparison with the past 12
  months, how do you expect that consumer prices
  will develop in the next 12 months? They will
•  a) increase more rapidly
• b) increase at the same rate
• c) increase at a slower rate
• d) stay about the same
• e) fall
• f) don't know
•  

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Quantification of inflation expectations (3)

• 1. Balance statistics BS 1a ½ b - ½ d-1e

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Quantification of inflation expectations (4)

• 2. Normal distribution adjusted Carlson-Parkin
  method

Source Batchelor, Orr, 1988
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Quantification of inflation expectations (5)

• Making the the necessary transformations, the
  following results are obtained

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Quantification of inflation expectations (6)

• Quantification of perceived inflation
• 
  
  (10)
• Where

• Assumptions for estimating moderate inflation
• The average value of actual inflation rate over
  the whole sample
• The running mean of actual inflation
• A linear interpolation between the average of the
  first half of the sample and the average of the
  second half of the sample
• Respondents do not make systematic errors
• Moderate inflation changes linearly and it is
  needed to quantify the moderate inflation in
  order to minimize the sum of the square
  differences between actual and quantified
  perceived inflation.

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Quantification of inflation expectations (7)
Quantification of inflation expectations and
perceived inflation
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Quantification of inflation expectations (7)

• 3. Uniform distribution adjusted method

The solutions of the equations is as follows
Source Lyziak (2003)
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Quantification of inflation expectations (7)

• Quantification of inflation expectations using
  normal and uniform distribution function

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The VAR model with exogenous variables (1)

• Data description
• The analysis is based on monthly data covering
  the period 2001M05-2009M9.
• All time series are monthly and the data are
  obtained from Eurostat, NBR, NBP, MNB, CNB,
  INSSE.
• The VAR model has following endogenous variables
• CORE denotes HICP excluding unprocessed food and
  energy components, 2005100
• EXP denotes inflation expectations relative to
  perceived inflation
• GAP is the output gap .The series was determined
  by applying Hodrick-Prescott Filter to monthly
  real GDP series. The monthly data were calculated
  by interpolating the quarterly seasonally
  adjusted real GDP data (expressed in national
  currency) in logarithm through Chow-Lin method
  using as indicator variable the industrial
  production
•  - and exogenous variables
• OIL is the Brent crude oil price in domestic
  currency, which is calculated as the price of the
  oil (in US dollars) multiplied with the monthly
  average of the exchange rates between national
  currencies and the US dollars
• PPI_EU is the PPI in the EU-27, 2005100
• FOOD is the producer price index of the domestic
  food industry, 2005100
• ENERGY is the producer price index of energy
  sector, 2005100
• I_EUR_3M is EURIBOR 3-month money market rate, .

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The VAR model with exogenous variables (2)

• The Augment Dickey-Fuller test results show that
  all variables are stationary. Note that some of
  the variables were transformed logarithmically
  (L) or/and for others the first difference (D)
  was taken.

According to Schwarz and Hannan-Quinn
information criteria, the VAR models includes 1
lag.
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The VAR model with exogenous variables (3)

• Impulse response function and variance
  decomposition
• the case of Romania

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The VAR model with exogenous variables (4)

• Impulse response function and variance
  decomposition
• the case of Hungary

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The VAR model with exogenous variables (5)

• Impulse response function and variance
  decomposition
• the case of Poland

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The VAR model with exogenous variables (6)

• Impulse response function and variance
  decomposition
• the case of Czech Republic

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Testing rationality (1)

• Testing the homogeneity of different demographic
  groups

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Testing rationality (2)

• Rationality test is given by the equation
• Where pt is the inflation at time t and pte is
  the expected inflation for time t.
• If the inflation expectations are rational a
  must be equal to zero and ß must be equal to one.

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Conclusions

• Obtained results using Carlson-Parkin approach
  show that
• Inflation expectations and perceived inflation
  are correlated with actual inflation
• However there are some periods of misperception
  due to factors like adhering to the EU or global
  crisis.
• Chosen distribution functions in our studies do
  not influences the results of inflation
  expectations
• VAR models depicts that only in case of Romania
  and Czech Republic exists a relationship between
  inflation expectations and inflation (
  expectations influence actual inflation).

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• In case of Hungary and Poland, national banks
  succeeded to break the link between inflation and
  inflation expectations
• In the case of Romania and Hungary, the group of
  respondents divided by level of education is
  heterogeneous expected inflation decrease once
  the level of education is higher
• In case of Hungary inflation expectations
  decrease once the level of income increases
  group divided by the level of income is
  heterogeneous
• For full sample, only in case of Czech Republic
  and Poland inflation expectations are rational

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• Thank you!