Do petrol prices affect inflation and inflation expectations? Evidence from New Zealand

Abstract

Due to their high visibility, petrol prices shape households' inflation expectations. This paper investigates the dynamic effects of petrol price shocks on one- and five-year inflation expectations in New Zealand; effects on headline and core inflation are also analyzed. Estimating partially identified structural vector autoregression models using Bayesian techniques, we show that petrol price shocks had a slightly delayed but persistent effect on one-year inflation expectations, whereas five-year inflation expectations were largely insensitive to these shocks. We also show that headline inflation increased immediately in response to petrol price shocks, while core inflation remained unaffected. Counterfactual analysis reveals that inflation and inflation expectations would have been higher in the absence of petrol price shocks during the second half of 2020. The results underscore the importance of petrol prices in influencing households' short-term inflation expectations, offering valuable insights for policymakers focused on managing the cost of living and inflation expectations in New Zealand.