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    Is this excuse valid?

    Fatih Özatay, PhD17 May 2011 - Okunma Sayısı: 869

    In the case with Turkey, the difference between the headline inflation and the consumer inflation will be quite wide if the recent trend proves temporary.

    For a long time, I talked about the fact that the gap between the consumer inflation and the headline inflation calculated with the "l" index that the Central Bank of Turkey (CBT) pays more attention to. In the last months, a movement in the opposite direction was observed; so I think we would rather get back to this issue. By the way, let me stress that the l index excludes the prices of energy, food, tobacco, alcoholic beverages and gold which are considered to be out of the scope of impact of the monetary policy.

    As you might remember, consumer inflation has always stood above the headline inflation since 2006. This was not a usual situation since there is a purpose in defining a different consumer index excluding the price of a number of goods and services and calculating the inflation rate on the basis of the movements of this index. 

    Consumer inflation must converge with the headline inflation
    Here is the purpose:  You normally expect that the future course of consumer inflation will coincide with the current and the anticipated future course of headline inflation. What is more, the economic policy in effect aims to influence the movements in headline inflation. It is assumed that this way consumer inflation will eventually converge with the headline inflation. If this is the case, the differences between the headline inflation and consumer inflation must disappear when long term averages are considered. In other words, the average difference for a sufficiently long period must be close to zero.

    If the gap tends to narrow down but the average difference is significantly different than zero, this implies that the headline inflation indicator will not serve its purpose. What is more, if this is the case, in periods where the consumer inflation stands considerably beyond the inflation target, you cannot refer to the course of headline inflation as evidence that there is no need to increase the policy rate. This would be invalid and would mean that you are coming up with excuses. 

    Deviation is too high
    So how is the current outlook? Figure 1 below which shows the difference between consumer and headline inflation answers this question. The gap closed down considerably over the last couple of months. But as can be noted, such convergence was observed also before. However, in the end, consumer inflation diverged from and almost always stood above the headline inflation. The average difference for the period since 2006 is 2.7 percent. Given the inflation target at 5.5 percent, this is quite high. Another measure: In April 2011, consumer price index was 13.1 percent higher than the headline index, almost corresponding to the sum of inflation targets of 2.5 years.

    Central banks applying inflation targeting regimes do not change the policy rates is headline inflation is compatible with the inflation target. Because they consider that the targeted consumer price index will eventually adjust to the headline inflation. However, in the case with Turkey, the difference between the headline inflation and the consumer inflation will be quite wide if the recent trend proves temporary. Then, the low headline inflation is of no use other than providing the CBT with an excuse. Therefore, we have to closely monitor the difference between the two rates and be cautious about potential excuses. 

    fo 1705

    Figure 1: The difference between annual consumer inflation and annual headline inflation: January 2006 - April 2011. Source: TURKSTAT.


    This commentary was published in Radikal daily on 17.05.2011