Asset Prices and Consumer Prices: Exploring the Linkages

It is a well-established fact in monetary economics that money and credit developments may affect consumer price inflation directly as well as indirectly via changes in asset prices, while at the same time asset price fluctuations can independently affect monetary and real developments. This has led to proposals to assign a more prominent role to asset prices in central bank’s toolkit of leading indicators for future developments in consumer price inflation. In this study, we examine, in the context of reduced-form inflation equations, the importance of different variables (including standard explanatory variables) as well as some specific asset price variables (i.e., the changes in housing and equity prices, a yield spread and oil prices). Against this background, we make use of a panel approach, covering data for 17 industrialised countries and the euro area. Three main results emerge out of our analysis. First, a standard framework explaining current inflation by (lagged) developments in inflation, the output gap, short-term interest rates, oil prices, house and stock prices and the exchange rate seems to perform quite well, although the explanatory power of the equations decreases with the length of the time horizon. Second, as regards the role of asset prices, it can be shown that house price movements seem to provide more useful information on future consumer price developments than movements in equity prices. Finally, the results of the analysis show that broad monetary developments become more relevant as the time horizon lengthens. By contrast, equity prices and the yield spread seem to be somewhat less informative. JEL Classifications: E37, E44, E5