What Common Factors are Driving Inflation in CEE Countries?

Abstract

We investigate commonality and heterogeneity of inflationary processes in ten Central and Eastern European (CEE) countries over the period 2001-2013. The research is important for the analysis of monetary policy as it helps understand the origin of price formation from both sectoral and country perspective. With a multi-level factor model we decompose product-level inflation rates into the CEE region-wide, sector, country, country-sector, and idiosyncratic components. The outcomes indicate that CEE region-wide and country specific components are more persistent than sector and product-level components, which is in line with similar studies for core EU countries. Regional factors explain about 17% of variance in monthly price changes, which is more than any other factors (below 10% each). This result is at odds with the assumptions of many sectoral DSGE models and empirical evidence on the importance of sectoral price shocks in developed economies. The difference may be related to the conclusion that the first regional factor is associated with common disinflationary process that occurred in CEE economies in the 2000s, whereas the second one reveals significant correlations with global factors, especially commodity prices and euro area price developments.