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Inflation story of the two crises
Let me say it at once: changes in gross domestic product (GDP) after the 2001 crisis and the 2008 crisis are completely in the opposite direction with the changes in inflation rate. The possible reasons for this situation might play a significant role in determining the future shape of the monetary policy. Let me express it more clearly. But first let me re-present the GDP graph I gave last Thursday.
Figure 1 gives GDP data in the 2001 crisis and in the last crisis in overlapping order. The peak GDP values before each crisis are represented with 100. The GDP values for the rest of the period are calculated in this parallel. GDP data are analyzed over an interval between the last four quarters preceding the peak level and the date when the peak level is re-achieved after the crisis. The period in the horizontal axis labeled '0' indicated the periods where GDP peaked before each crisis. When you move rightwards, you see the movement before the crisis and vice versa. The dotted curve which covers the whole frame horizontally shows the GDP movements for the 2001 crisis. The GDP outlook can be summarized as follows: similar GDP movements are observed in both of the crisis.
In Figure 2, the horizontal line covering the whole frame shows the consumer prices inflation between February 2001 and December 2002. The shorter curve shows the development of inflation since September 2008. Inflation rates differ significantly between periods just as in GDP values. However for inflation rates there is no sense in doing the same analysis made for GDP. Instead of this, inflation rates in the two periods are calculated separately in each axis so that the movements can be seen clearly. Please do not get confused by the dates given in the horizontal axis; only the period between February 2001 and December 2002 is shown. And for the global crisis, September 2008 corresponds to February 2001.
The inflation outlook can be summarized as follows: in the last crisis, inflation falls rapidly as the crisis intensifies. As the trough ends and economy starts to recover (as of the last months of 2009) inflation tends to rise. But in the 2001 crisis, an opposite movement was observed; inflation increased as the crisis deepened and tended down as the recovery began. In short, GDP movements, which were in the same direction in case of both of the crises, turn into opposite directions when it comes to inflation. We should think of the reasons and outcomes of this asymmetric behavior. Of course GDP movement is not the only determinant of inflation. To put it with a more technical language, if the only indicator of inflation was the difference between the potential level of production and actual level of production, i.e. output gap, inflation would have been expected to move in the same directions in the both crises.
There are different determinants of inflationary movements. For instance exchange rate movements and energy and base metal import prices determined by international conditions are among these. So we should also check in which direction the named variables moved during each crisis. This can easily be done, but this is not my point. What I want to mention are as follows:
Under these circumstances, how meaningful it is to focus on the difference between the potential level of production and actual level of production, i.e. output gap, when commenting on monetary policy? More concretely, is the future movements of the output gap too important for the future shape of the interest rate policy? Was the Central Bank right in putting emphasis on the output gap or delivering that impression?
These questions are yet to be answered. I will try to comment on these whenever the agenda priorities allow.
Figure 1: GDP movements in the 2001 crisis and the last crisis quarterly data net of seasonal effects and the changes in the number of working days)
Figure 2: Annual consumer price inflation (%, dotted lines: February 2001 - December 2002, bold line: September 2008 - March 2010)
This commentary was published in Radikal daily on 08.04.2010