Inflation Responses to Commodity Price Shocks – How and Why Do Countries Differ?

A nice paper which does offer some answers for India’s inflation problem. It looks at how inflaiton moves post commodity price shocks in different econs:

This paper relates the inflationary impact of commodity price shocks across countries to a broad range of structural characteristics and policy frameworks over the period 2001-2010, using several approaches. The analysis suggests that economies with following characteristics have higher inflation:

• higher food shares in CPI baskets,
• fuel intensities,
• and pre-existing inflation levels.

Countries with more independent central banks and higher governance scores seem to have contained the impact of these shocks better. The effect of the presence of inflation targeting regimes, however, appears very modest and not evident during the 2008 food price shock.The evidence suggests that trade openness, financial development, dollarization, and labor market flexibility do not significantly influence the way in which domestic inflation responds to international commodity price shocks.

India has a problem in all three. Food sharesa re fairly high in CPI, pre-existing inflation levels remain high leading to rise in inflation expectations. Fuel intensity is expected to rise as more  people come into the inclusive growth club..

It also looks at qs like whether inflation moves to core or vice-versa. It seems headline moves to core but speeds differ across econs. The speed is faster in advanced and slower in developing world..

Solutions to lower inflation:

• Countries can, however, influence the degree to which domestic inflation reacts to international commodity price movements: better overall governance, greater central bank autonomy, and, to a lesser extent, the adoption of inflation targeting frameworks seem to help anchor inflation expectations and reduce second-round effects. However, the evidence suggests that the overall confidence in institutions may be more important than whether a country declares itself formally as an inflation targeter or not.
• Policy actions also matter: around the 2008 commodity shock, tighter monetary policy (as measured by the real interest rate) helped contain the inflationary impact. To a lesser degree, this is also true for tight fiscal policy.
• If inflation is already relatively high to begin with, commodity price shocks have a substantially higher pass-through to domestic inflation. 

Further research could examine more systematically the formation of inflation expectations around commodity price shocks and their influence in shaping inflation dynamics; more work using microeconomic information on price movements around such shocks could also lead useful insights.