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A part of this work was featured in October 2010 Regional Economic Outlook of the Asia and Pacific Department. We would like to thank Vivek Arora and Roberto Cardarelli for their invaluable guidance, and Yiqun Wu for excellent research assistance. We would like to also thank seminar participants at IMF’s Asia and Pacific Department, Hong Kong Monetary Authority, Korea Development Institute, and Lingnan University. The usual disclaimer applies.
By the end of 2007, headline inflation in emerging East Asia reached 5.3 percent, double the rate at the start of the year, and 6.9 percent by May 2008.
The shares of food and energy in the average emerging Asian CPI basket are nearly 40 percent and 10 percent, respectively, both of which are higher than the average for emerging economies worldwide. In India and Indonesia, the CPI shares of food and energy are higher than the Asian average.
Over the last decade, simple contemporaneous correlations between headline inflation and core inflation, on the one hand, and between core inflation and food and energy prices on the other hand, have been quite high (at 0.8 and 0.4, respectively). This suggests that changes in food and energy prices feed through quickly to core inflation, possibly through inflation expectations, wages, and other input costs.
Before estimating the model we conduct unit root and cointegration tests, to identify and take account of long term relationships between macroeconomic variables for each country. We also test for weak exogeneity of
It is well known that these residuals only depend on the rank of the cointegrating vectors and do not depend on the way the cointegrating relations are exactly identified.
However, for all economies the results obtained under the two orderings are similar.
It should be noted that demand pressures from China can drive commodity prices even if China does not have pricing power over international commodities.
The shock is about 3 standard errors in magnitude, which causes 1 percent increase in GDP on impact, and 2.5 percent on average within two years.