Inflation -relative price variability relationship: The case of Turkey

Nowadays, it is known that many economies have been faced with inflation problem and inflation has become almost a part of life for these economies. For a long time, it has been acknowledged that inflation may affect real economic variables through its impact on the relative price variability. In high inflationary periods, the signaling characteristic of relative prices to economic agents has been weakened because the perception of economic agents is getting difficulty in distinguish relative/absolute, temporary/permanent price changes. For this reason, when inflation leads to changes in relative prices, the efficient allocation of resources is prevented and welfare losses arise. The purpose of this study is to separately investigate the relationship between inflation and relative price variability on the basis of both expenditure and sub-region in Turkey. For this purpose, first, inflation rate and relative price variability of each expenditure group and sub-region were calculated by using monthly consumer price index of 31 expenditure groups in 26 regions for the period of 2003:01-2014:01. Later, correlation analysis was performed to determine the direction and the degree of the relationship between the two variables. Later, the two variables which were separately generated for each 26 regions and for 31 expenditure groups were subjected to Granger causality test, variance decomposition and impulse-response analysis within the framework of the vector autoregressive (VAR) model. The results of the analysis for expenditure groups have shown that there is usually a bi-directional or unidirectional causality from inflation to relative price variability. The results based on regional data have shown that the direction of the causality for many sub-regions runs from relative price variability to inflation.