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Analysing inflation dynamics in Iceland using a Bayesian structural vector autoregression model

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  • Stefán Thórarinsson

Abstract

This paper seeks to determine what drives inflation variation in Iceland and examine the extent to which local currency pricing is present. To that end we define and estimate a Bayesian structural vector autoregression model. For identification we employ the method developed by Baumeister and Hamilton (2015), defining priors on the impact matrix and on the long run behaviour of the model. We find that supply shocks and exchange rate shocks are the largest contributors in short run dynamics of inflation while foreign shocks dominate the medium and long run horizons. Our results strongly suggest that local currency pricing is largely absent. A test of robustness suggests that our results w.r.t. foreign influences on domestic inflation hold. Whether foreign demand or foreign inflation plays a larger role in determining long horizon variation in inflation seems to vary considerably over the period considered.

Suggested Citation

  • Stefán Thórarinsson, 2022. "Analysing inflation dynamics in Iceland using a Bayesian structural vector autoregression model," Economics wp88, Department of Economics, Central bank of Iceland.
    • Handle: RePEc:ice:wpaper:wp88
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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