Recent long-term management of relation across Czech Republic price indices and exchange rates

Abstract

PURPOSE: This article examines the data related to four nominal variables to illustrate their long-term joint evolution, emphasizing the process of coordinating economic agents to adjust economic decisions when inflation accelerates, and the impulse on other markets, in particular the foreign exchange market. The article appears as relevant to the extent that the long-run common evolution of the nominal variables is indicative of a kind of indexation. The article is relevant to confirm some economic interaction of agents and markets in the framework of a monetarist economic mechanism. With the co-integration approach we bear out common trends in the time series used as an assertion of the coherence in the adjustment between a set of nominal variables.

DESIGN/METHODOLOGY/APPROACH: We run a set of co-integration techniques embedding three prices indices and the nominal exchange rate for the Czech Republic. We run the augmented Dickey Fuller test for bearing out long-run relationships between pair of sequences and for asserting the same order of co-integration across the four sequences. As recently developed, we conduct a multivariate strategy for bearing out the existence of at least one co-integration vector, resorting to the Johansen rank test. Later, the Error Correction Model demonstrated the short run dynamics, supporting the idea that the Consumer Price Index CPI explained by the dynamics of the model, adjusted to the equilibrium in the next period.

FINDINGS: The co-integration technique pursued the identification of common stochastic trends in four Czech time series. We confirmed the stationarity of the four variables in first differences, confirming a convergence to a long run equilibrium. When applying the Error Correction Model, we born out the adjustment mechanism towards the long run equilibrium, when any short rung shock affected the structure of the model. When confirming the common long-run trends in the indices and the exchange rate, the variables in questions loom as reliable predictors of the objectives of macroeconomic stabilization.

PRACTICAL IMPLICATIONS: The article provides support for the close long-run evolution of nominal variables, as a set of indicators of the evolution of the mechanism of prices in the economy. The conclusions endorse the use of nominal tools in pursuing the nominal stabilization of the economy. The conclusion reinforces the relevance of alternative prices indices and the exchange rate as predictors of the behavior of headline inflation. Our conclusions can serve as a support for the tracking of alternative variables to anticipate the stabilization path.

ORIGINALITY/VALUE: This article emphasizes the connection between nominal time series during a period marked by an unusual inflation upsurge, and the subsequent phase of monetary tightening and convergence towards lower inflation rates. The discussion is very relevant to the extent that amid a process of indexation of nominal variables, the economy is looking for a nominal anchor able to give credibility to economic policy. In such terms in Czech Republic the economic policy has transmitted some signals of a restrictive monetary policy and fiscal adjustment intended to stick the expectation of the economic agents, eager to find a nominal anchor.