Working Paper: CEPR ID: DP12652
Authors: Kristin Forbes; Lewis Kirkham; Konstantinos Theodoridis
Abstract: This paper uses a “trendy” approach to understand UK inflation dynamics. It focuses on the time series to isolate a low-frequency and slow moving component of inflation (the trend) from deviations around this trend. We find that this slow-moving trend explains a substantial share of UK inflation dynamics. International prices are significantly correlated with the short-term cyclical movements in inflation around its trend, and the exchange rate is significantly correlated with movements in the slow-moving, persistent trend. Other variables emphasized in standard inflation models—such as slack and inflation expectations—may also play some role, but their significance varies and the magnitude of their effects is substantially smaller than for commodity prices and the exchange rate. These results highlight the sensitivity of UK inflation dynamics to events in the rest of the world. They also provide guidance on when deviations of inflation from target are more likely to be temporary, and when (and how quickly) a monetary policy response is appropriate.
Keywords: Phillips Curve; UK Inflation; UCSV; Exchange Rate; Slack; Inflation Expectations; Monetary Policy
JEL Codes: E31; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| slow-moving trend in UK inflation (E31) | variation in headline inflation (E31) |
| slow-moving trend in UK inflation (E31) | variation in core inflation (E31) |
| international prices (P22) | short-term cyclical movements in inflation (E31) |
| 10% depreciation in the sterling exchange rate (F31) | increase in trend inflation (E31) |
| changes in slack (J29) | inflation dynamics (E31) |
| inflation expectations (E31) | inflation dynamics (E31) |