Achieving low inflation in transition economies: the role of relative price adjustment

Abstract

The analysis of inflation rates for the individual commodities that constitute the CPI in 21 transition economies suggests that substantial relative price adjustments take place throughout the transition process, following even comprehensive initial liberalization. Typically, a few significant positive relative price shocks underlie inflation, while other prices show some downward stickiness. However, the estimated direct impact of relative price adjustment on inflation is, overall, modest and depends on the extent of monetary accommodation, which is a dominant factor in explaining inflation. Nominal wage shocks and inertia are also important. Hence, the achievement of low inflation in transition economies is not necessarily constrained by relative price adjustment, provided there is a willingness to use monetary policy sufficiently aggressively, even if this may entail significant nominal exchange rate appreciation and, most likely, some output costs in the short run.