# Presentation: 507880

## PDOE Macroeconomic Model #2: Consumer Prices

- Mark Rodekohr, Ph.D.
- June 2004
- South Asian Regional Initiative – Energy
- Bangkok, Thailand

## Two Models of Inflation - I

-  Quantity theory of money – growth of the money supply is equal to the sum of the growth in output and the inflation rate.  Any misalignments in the growth of output and the money supply will be reflected in the inflation rate.  There are many of examples of this throughout history related to government “printing money”

## Two Models of Inflation - II

-  Cost-Push Theory – states that increases in prices can be traced to increases in the costs of primary inputs such as wage rates, interest rates, prices of imports, and movements in exchange rates.
-  Demand-pull theories attribute prices increases to autonomous increases in demand.

## PDOE Model

-  This model allows for both cost-push and demand-pull factors.
-  The energy price is one of the cost-push factors along with wage rates, interest rates, prices of imported goods and exchange rate adjustments.
-  Demand-pull factors include excess demand variables related to misalignment between the growth in the money supply and output growth.

## Model Structure

-  The consumer price index (CPI) is a function of wages, the 90-day T-bill rate (indicator of interest) index of imported fuel prices, index of non-fuel imports and an excess liquidity variable expressed as the ratio of money supply to gross domestic product.

## Inflation Model

## Data: Inflation Model

## Implications of Inflation Model

-  In the short run a 10 percent increase in the imported fuel price results in a 1.1 percent increase in the consumer price index.  In the long run (you divide the short run figure by 1-lag value) a 10 percent increase in the imported fuel price results in a 2.5 percent increase in the consumer price index.
-  In this model neither wages nor the excess demand variable are significant.   This is not consistent with economic theory or is likely to hold true for most countries.

## Forecasting Exogenous Variables: Wages

## Forecasting Exogenous Variables: TBILL Rate

## Forecasting Exogenous Variables: Fuel Price

## Forecasting Exogenous Variables: Non-Fuel Prices

## Forecasting Exogenous Variables: Excess Demand

## Conclusions

-  Some of the variables, namely wages and excess demand are not significant counter to economic theory and the experience of other countries.
-  The imported fuel price was used for a lack of data.  If possible substitute the average fuel price.  This would give a clear link between domestic energy issues and inflation.
-  Many of the exogenous variables are forecast using time and a lagged dependent variable.  Other formulations can and should be used.
-  Recall only first order effects are projected.  However these should be sufficient for most analyses.

## Exercises

-  Try one of the following:
- Estimate inflation equation using data from your own country.
- Estimate inflation equation using U.S. data provided here.
- Estimate the impact of a 10 percent increase in non-energy imports in both the short and long run using the model estimates shown here.

## Internet Resources

-  Macro Data Generator: _[http://www.digitaleconomist.com/econ_data.html](http://www.digitaleconomist.com/econ_data.html)_
-  Macro Models: _[http://www.digitaleconomist.com/office_hours_macro.html](http://www.digitaleconomist.com/office_hours_macro.html)_
-  Macro Terms: _[http://www.digitaleconomist.com/glossary_macro.html](http://www.digitaleconomist.com/glossary_macro.html)_
- Macro Course: _[http://www.mankiw.nelson.com/web_resources.html](http://www.mankiw.nelson.com/web_resources.html)_