Modelling Determinants of Inflation in CESEE Countries: Global Vector Autoregressive Approach

Abstract

After a prolonged period of relatively stable price levels, the beginning of the third decade of the 21st century has brought inflation once again into the spotlight. This paper focuses on the inflation dynamics in a set of post-communist countries that eventually became members of the European Union. Due to EU accession augmented by the globalization process and involvement in global value chains (GVC), the international impacts are becoming progressively important for the domestic inflation dynamics and domestic variables are not sufficient to fully describe the domestic inflation dynamics. The employed methodology, Global Vector Autoregressive (GVAR) approach, allows modelling interactions and spillovers among countries, making the most of its advantages over the usual VAR models that model each economy separately and panel models, where countries are often treated as independent units. The results of the empirical analysis confirm that the globalisation process has led to increasing the importance of international impacts on the domestic inflation dynamics. On the other hand, the results also indicate that accounting for a larger set of countries decreases the severity of the commodity price shocks and makes them less persistent. Furthermore, monetary policy acts as a buffer against adverse shocks, especially in the countries that are still not members of the euro-zone. The findings of the paper show that the analysed countries are pronouncedly heterogeneous. Hence, each of the analysed economies has its own set of country-specific factors which, from country to country, play a more important or a less significant role in explaining national inflation dynamics. Thus, the paper should contribute to a more comprehensive understanding of the inflation dynamics in the policy-making context.