Algeria: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
10 Feb 2004
eISBN:
9781451811391
Language:
English
Keywords:
ISCR; CR; chapter III; state-owned enterprise sector; chapter; food price; price liberalization; inflation well; inflation process; inflation determination; Exchange rates; Food prices; Monetary base; inflation in Algeria
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Algeria remains heavily dependent on the hydrocarbon sector and still maintains a sizable and inefficient state-owned enterprise sector. Against this background, the paper addresses two different issues with important implications for macroeconomic stability in Algeria. The paper proposes the replacement of directed credit to large loss-making public enterprises with temporary and explicit budget subsidies. It also shows that money, volume of imports, and weather conditions have a strong impact on price movements in the short term, whereas the exchange rate has none.

Abstract

Algeria remains heavily dependent on the hydrocarbon sector and still maintains a sizable and inefficient state-owned enterprise sector. Against this background, the paper addresses two different issues with important implications for macroeconomic stability in Algeria. The paper proposes the replacement of directed credit to large loss-making public enterprises with temporary and explicit budget subsidies. It also shows that money, volume of imports, and weather conditions have a strong impact on price movements in the short term, whereas the exchange rate has none.

III. Determinants of Inflation in Algeria31

A. Introduction

28. Algeria has achieved price stability since the completion of the Fund-supported stabilization program (1994—1998). Macroeconomic stability has been restored, the external position has been strengthened and prices remain stable except for 2001, where inflation increased marginally, though remaining below 5 percent.

29. However, a study on money demand shows that the current macroeconomic environment carries inflationary risks. The study confirms the stability of money demand in Algeria and shows that strong money growth fueled by high hydrocarbon revenues and high government spending ignites inflation. Thus the 2002 excess monetary balances could put pressure on prices.32

30. In 2002, the traditional close relationship between inflation and monetary growth broke down, as velocity declined. Increased political and social tensions in a context of high oil revenues have led the authorities to adopt an expansionary fiscal policy since 2001, in order to create jobs and improve the living conditions of the population. As a result, and despite some tightening of the monetary stance, excess reserves of banks increased considerably due to the nonsterilization of the government share of net foreign assets. So far, however, the acceleration of M2 growth has not translated into higher inflation as the growth of the Consumer Price Index (CPI)—following a slight increase in 2001—decelerated in 2002.33

31. Inflationary pressures from looser financial policies may have dampened by offsetting nonmonetary factors. The 2002 behavior of prices did not follow the money market equilibrium, indicating that nonmonetary factors could have offset the effects of the increase in the money supply. For example, high agricultural output and reduction in trade barriers may potentially explain low inflation.

32. Against this background, this paper examines the characteristics of the inflation process in Algeria and its main determinants using three different approaches. The objective is to find out what factors influence price movements and to assess the extent to which a sharp increase in prices should in retrospect be viewed as a monetary phenomenon. After presenting the structure and composition of the CPI, and the evolution of inflation in Algeria, the paper uses the following three approaches to define the characteristics of inflation and explore gradually its determination:

  • A univariate decomposition approach to shed more light on the characteristics of the CPI movements, by decomposing inflation into three unobserved components: seasonal, trend, and irregular.

  • A bivariate approach to reveal the leading indicators of inflation, by running Granger causality tests and examining the information content of each of the traditional cost-push and demand pull factors in association with inflation in Algeria: money and credit, volume of imports, foreign prices, and the exchange rate.

  • A multivariate approach to derive a theoretical model to determine inflation, by using co-integration and error-correction techniques.

33. The analysis indicates that both monetary and real factors affect inflation in Algeria.34 The first approach shows that inflation is on a downward trend since Algeria’s economic liberalization, hi addition, given the weight of food prices in the CPI basket, factors affecting food price movements, such as a good harvest, or a fall in international food prices, influence price movements in Algeria. The second approach indicates that each of the traditional cost-push and demand pull factors (M1, the volume of imports, and foreign prices) has separately predictive information for CPI movements. The third approach confirms that inflation is positively related to both money supply and the exchange rate, and negatively related to income in the long run. In the short run, exchange rate movements do not seem to affect price changes (based on the empirical model), while movements in Ml and output seem to predict well CPI changes, thus confirming the quantity theory of money.

34. The study shows that the coexistence of high liquidity and low inflation in 2002 can be attributed to both monetary and real factors. This is partly explained by the deceleration of the narrow money M1 growth in 2002, as the acceleration of M2 growth is mainly due to the automatic sterilization of the state-owned hydrocarbon company’s deposits given their “inactive” nature. It also results from higher agricultural output, associated with the implementation of the National Program for the Development of Agriculture.35 It could be as well due to the reduction in trade barriers. Although there is no available data to empirically confirm the relation between easing trade barriers and the fall in inflation, the declining trend in price movements since the beginning of trade liberalization in 1996 supports this argument.36 Policy implications are summarized in the conclusion.

B. Background

Composition and Structure of the CPI

35. The CPI for the capital Algiers is the most accurate price index in Algeria.37 The index is compiled monthly by the National Board of Statistics and composed of 260 goods and services. Weights are based on the 1988 National Household Consumption Survey, and the reference year is 1989. The CPI is calculated according to the Laspeyres formula.

36. Movements in food prices dominate movements in the CPI. Table 1 shows that food and beverages account for 44 percent of the consumption basket. Consequently, factors affecting food prices dominate movements in the CPI (Figure 1 and Appendix II). These factors include weather conditions, wages, import prices, and exchange rate movements (owing to the high import content of foodstuffs).

Table 1.

Algeria: Consumer Price Index Basket and Volatilty

article image
Source: Algerian National Board of StatisticsNote: Coefficient of Variation is defined as the ratio of standard deviation of the monthly inflation of each item to its respective mean.
Figure 1.
Figure 1.

CPI 12-month changes, 1996-2003

(in percent)

Citation: IMF Staff Country Reports 2004, 031; 10.5089/9781451811391.002.A003

37. Due to price liberalization, the coefficient of variation of the CPI is high during 1997–2003. Food and beverages have the most volatile prices throughout the entire sample period due mainly to liberalization of many administered prices starting in 1994. The volatility of prices of clothing and footwear, which are subject to foreign competition, also increased during 1996–2003 due to Algeria’s increased international economic integration (Table 1).

Evolution of Inflation during 1970–2002

38. In the 20 years up to 1990, when price liberalization started, annual inflation in Algeria averaged about 9 percent (Figure 2). Inflation surged only once, after the first oil shock in the mid 1970s, reflecting higher import prices and strong demand pressures in the nontradables sector owing to the oil windfall. However, price stability was only apparent: large budget deficits were being monetized, causing a monetary overhang. Inflationary pressures were repressed by pervasive price controls—in 1990, more than 50 percent of the items in the consumer price index were subject to either price ceilings or margin limits. This resulted in widespread supply shortages.38

Figure 2.
Figure 2.

Inflation Rate, 1970-2002

(in percent)

Citation: IMF Staff Country Reports 2004, 031; 10.5089/9781451811391.002.A003

39. In 1990–91, realignments of the exchange rate coupled with price liberalization and the monetization of large fiscal deficits led to price increases (Table 2.). The episodes of large exchange rate devaluations resulted not only in inflation, but also in growing import and external debt servicing costs, and revealed the hidden losses of public enterprise. Moreover, in 1992–93, the authorities’ expansionary fiscal policy to support economic activity resulted in higher budget deficits. These imbalances continued to be financed through money creation, and, by the end of 1992, the 12-month inflation rate was 28 percent.

40. The 1994 stabilization program had a long lasting impact on inflation. The program included a large up-front devaluation (50 percent) geared to improving competitiveness and restoring external viability over the medium term.39 The devaluation contributed to an initial increase in inflation, which reached 39 percent at end-1994 (Figure 2). However, a restrictive fiscal ‘stance coupled with tight income monetary policies led to a sharp and durable decline in inflation. By end-1996, the 12-month rate of inflation was down to 15 percent, and to 6 percent by end-1997. This successful disinflation policy was accompanied by a comprehensive price liberalization: administered prices more than doubled over 1994–96, and by early 1996, only less than 15 percent of the items in the CPI were regulated.40 While price liberalization allowed for the realignment of relative prices, its impact on CPI changes was offset by the decline in prices of imported products stemming from the appreciation of the dinar vis-à-vis European currencies (Figure 3), and by a prudent monetary stance as well as wage restraint, which made room for those adjustments without feeding inflationary pressures.

Figure 3:
Figure 3:

Variation of the Exchange Rate: 1994:01-2002:12

Citation: IMF Staff Country Reports 2004, 031; 10.5089/9781451811391.002.A003

41. Disinflation has continued over the past five years. This period was marked by low inflation. The continued decline in inflation, except for a temporary rebound in 2001, was in large part attributable to food and beverages prices, the movements of which mirrored the fall in international prices of basic foodstuffs. hi 2001, expansionary domestic policies—a large increase in public salaries, an easing of the fiscal stance and an accommodating monetary policy—coupled with increasing food prices resulted in a pickup in inflation to an annual average of 4.2 percent and to 7.5 percent by end-year. By contrast, in 2002, despite the 22-continuous expansionary fiscal policy, and the resulting M2 growth, inflation rate declined to less than 2 percent.41

C. Determining Inflation

Interpreting Unobserved Components

42. Seasonably, economic policies, and exogenous factors characterize the inflation process in Algeria. The previous analysis of the evolution and possible causes of inflation during 1990–2002 shows that the evolution of prices in Algeria is likely to be a combination of the effects of food prices, with their marked seasonality, economic policies, and external factors affecting the two former factors. A tentative interpretation of these factors could be that economic policies determine the evolution of “underlying inflation”, which would be represented by the statistical trend of the series. Along this trend, the seasonal behavior would be determined by factors affecting agriculture or timing of holidays, while exogenous events would influence the series on an irregular basis. A way of exploring this interpretation is to perform a univariate decomposition of the series into these three elements, trend, seasonal and irregular. A univariate decomposition of the series into their unobserved components can be done in many ways. Hence, an ARIMA-model-based method was used to decompose the price series into its different unobserved components (see Appendix III for a brief description of the methodology).

43. The univariate approach confirms that inflation in Algeria is on a declining path and is highly affected by agricultural production. Figure 4 presents the decomposition of the monthly inflation rate. Trend inflation has decreased steadily over time, as a result of the stabilization policies implemented in Algeria. The slight increase of the trend in 2001 reflects the combination of the 2000 expansionary fiscal policy combined with the increase in money supply. Inflation in Algeria shows a very stable and sizable seasonal pattern, peaking in May, August, December, and January and with troughs in February, April, and July. This seasonality can be associated with agricultural production, which reaches its peak in the summer and its trough afterwards.42 The irregular component of inflation is important over the entire sample. It captures quite well the period preceding the adoption of a new constitution in 1996, the political tensions and government reshuffling in spring 2001, and the May 2003 earthquake.

Figure 4.
Figure 4.

Algeria: Decomposition of CPI Monthly Changes, 1996:01-2003:07

(in percent)

Citation: IMF Staff Country Reports 2004, 031; 10.5089/9781451811391.002.A003

Leading Indicators of Inflation

44. Following the approach employed by Friedman and Kuttner (1992), this section examines the information content of each of the traditional cost-push and demand pull factors in explaining price movements, by using Granger causality tests. This technique helps identify the variables that provide significant information for predicting the future course of inflation in Algeria, which, in turn, could be used in the theoretical model of inflation determination and constitute a valuable input for policy makers in designing economic policies. The technique investigates the directional relationship between inflation and the various proxy variables for cost-push and demand pull factors.43 More specifically, inflation is regressed on both its past values as well as on the past values of each of the potentially explanatory variables.44 If these explanatory variables are statistically significant in the regression, then they provide information about inflation over and above that provided by past values of inflation.45

45. All variables are expressed in first differences since they have unit roots. Monthly data for the period 1997–2002 are used.46 The variables are expressed in logarithmic terms. An investigation of the time series properties of all variables using both the Dickey-Fuller (DF) and the Augmented Dickey-Fuller (ADF) tests shows that all variables except have unit roots (Appendix IV). This implies that the variables are non-stationary and hence may exhibit some spurious correlations.

46. The overall results underscore that currency in circulation, M1, credit to the economy, foreign prices, and volume of imports constitute each a good leading indicator for prices movements. Appendix V presents the overall results of this exercise. The results of the tests including M1 and volume of imports (proxied for output) confirm the quantity theory of money. There is also strong evidence that causality runs from foreign prices to local prices, showing the pass-through effect in an open economy. The graphical representation of inflation and the variation in each of the above-mentioned variables (Appendix VI) also shows the existence of a relation between these variables and price movements.

Empirical Model of Inflation

47. This section empirically estimates a simple theoretical model of inflation determination, which will help policy makers in understanding the structural determination of inflation. Equation 6 represents the theoretical model of inflation (see Appendix VII). It predicts that an increase in money supply, in foreign prices, in real wages, in interest rates, and in the exchange rate will all drive prices up, while an increase in real income will lead to a decline in the inflation rate.

log⁡ Pt=α log⁡ Mt++ϕ  log⁡yt−+σ log wt++μ rt++δ Δ log⁡Pt−1++ν log⁡ et++γ log⁡Ptf++ut(6)

48. The empirical testing of the model is constrained by the limited availability of data. Volume of imports is used as a proxy for output.47 Real wages are excluded from the equation. Interest rates are also omitted from the model, because of the relatively underdeveloped nature of financial markets in Algeria. The model becomes as follows:

log⁡Pt=α⁢ log⁡Mt+ϕ⁢ log⁡yt+ν⁢  log⁡et+ut(6′)

49. The empirical approach is divided into two parts. First, Engle and Granger (1987) and Johansen and Julelius (1990) co-integration tests are run to determine the existence of a long-run relationship between P, e, Y, M.48 Both procedures indicate that there is a long-run equilibrium relationship between P and e, y, and M. The long-run equilibrium estimated for the period 1997:01–2003:03 takes the following form (figures in parentheses represent standard errors; figures in square brackets represent t-statistics):

log CPI = 0.42 log(0.02)[2.29] MI - 0.007 log(0.05)[−2.03] IMP - 0.17 log NEER(0.08)[−2.01](6“)

50. All the coefficients of the equation have the theoretically expected sign.49 In the long run, inflation in Algeria is positively related to money supply and the exchange rate, while it is negatively related to real activity (import volumes). More specifically, in the long run a 1 percent increase in M1 will raise inflation by 0.42 percent, while a 1 percent depreciation of the dinar/dollar exchange rate will increase inflation by 0.17 percent.50 Finally, a 1 percent increase in the proxy for real output will reduce inflation only by 0.07 percent confirming the quantity theory of money. The model tracks inflation well, and deviations are generally of a small magnitude (Appendix VIII). Figure 5 plots the actual and the fitted values of inflation.

Figure 5.
Figure 5.

Actual and Fitted Changes in the CPI

Citation: IMF Staff Country Reports 2004, 031; 10.5089/9781451811391.002.A003

51. The results suggest that in the long run monetary factors have a bigger impact on price changes in Algeria than exchange rate movements or output changes. This finding supports the monetarist argument on the power of monetary factors in the long run inflationary process.

52. To capture the short run dynamics of inflation, a “general-to-specific” modeling approach is followed and a general dynamic error-correction model is estimated.51 The general specification that is considered takes the form of an autoregressive distributed-lag model of the type:

Δ⁢Pt=ϕ0+ECt−1+∑n(ϕij⁢Δ⁢Xt−j)+εt(7)
j=0

where xt is the vector of regressors, EC is the error-correction component, and it is a serially uncorrelated error term.

53. The error correction model utilizes information in the error correction term of the long-run model to approximate deviations from the equilibrium and represent the short-run response necessary to move the system back toward its equilibrium. The error correction term is calculated as:

ECt⁢ =Pt−Pt(8)

where Pt is the actual value of P in the period t and P, is the fitted value of Pt estimated in equation (7).

54. The most parsimonious formulation of the equation (7), estimated for the period 1999:01–2003:03, is presented below (figures in parentheses represent standard errors; figures in square brackets represent t-statistics).

Δlog⁡CPI=−0.003−0.73EC(0.24)[−6.27]+0.65Δlog⁡CPI(t−1)(0.20)[3.23]+0.58Δlog(0.19)[3.07]⁡CPI(t-2)+0.64Δlog(0.17)[3.58]⁡CPI(t-3)+0.55Δlog⁡CPI(t-4)(0.15)[3.43]+0.44Δlog⁡CPI(t-5)(0.13)[2.29]+0.26Δlog⁡CPI(t-6)(0.11)[4.91]+0.60Δlog⁡MI(t-1)(0.12)[3.74]+0.51⁢Δ⁢log⁡M1(t-2)(0.13)[3.35]+0.45⁢Δ⁢log⁡M1(t-3)(0.13)[3.35]+0.37⁢Δ⁢log⁡M1(t-4)(0.11)[3.25]+0.21⁢Δ⁢log⁡M1(t-5)(0.07)[2.95]−0.06⁢Δ⁢log⁡IMP(t−1)(0.01)[−3.84]−0.03⁢Δ⁢log⁡IMP(t-2)(0.01)[−3.34]+0.02⁢Δ⁢log⁡IMP(t-4)(0.01)[−2.71]+0.01harvest(0.002)[2.21]R2=0.78DW=2.22

55. The results indicate that the parsimonious model has good statistical properties. The error correction term EC is significant at 1 percent level, confirming that the variables are co-integrated. It also shows the rapid adjustment of inflation toward its equilibrium value. That is, there is 73 percent feedback from the previous period into the short run dynamic process. The presence of serial correlation, or more general forms of autocorrelation, was rejected based on the Breutsch-Godfrey and Box-Pierce Q statistic. The Jarque-Bera test statistic confirmed normality, and the ARCH test rejected up to fourth-order heteroscedasticity in the disturbance term. Finally, the cumulative impulse responses to a one standard deviation in the variables of the equation confirm that prices respond highly to Ml movements and less to economic activity (see Appendix VIII).

56. The results show that money, volume of imports and weather conditions have a strong impact on price movements in the short run, whereas the exchange rate has none. The empirical evidence using the available data confirms the theory that excess money supply puts pressure on prices in Algeria. Changes in output and weather conditions have a less important impact on prices in the short term. The most striking result is the absence of short-term relation between the exchange rate and inflation. Theoretically it would be expected to see some pass-through effect from exchange rate movements to price movements, and this is confirmed if we use the subcomponent food prices instead of total CPI. However, the empirical absence of the exchange rate effect on price movements could be due to the existence of a parallel market that might contribute to the explanation of the relation between exchange rate and price movements, as well as to some statistical weaknesses such as the absence of data on tariff reduction, which could have offset the effect of exchange rate movements on inflation. The relation between the parallel market rate and inflation could however not be confirmed (or infirmed) given the lack of data.52

D. Conclusion

57. This paper emerged from the question “why inflation is not picking up in Algeria’s environment of high monetary growth”. It took a broad approach toward assessing the evolution of prices in Algeria, focusing especially on the period of moderate-to-low inflation in 1997–2002. The main conclusions are summarized as follows:53

58. Inflation is on a declining path since 1996. Economic liberalization, including price and exchange rate liberalization have had a positive impact on reducing inflation over the medium term.

59. Factors affecting food prices, such as weather conditions, influence price movements. The graphical analysis of price behavior shows that CPI movements reflect mainly movements in food prices, given the weight of food prices in total CPI.

60. The empirical analysis highlights that the increase in M2 does not necessary create inflationary pressures, and movements in narrow money M1 explain better price movements in Algeria than those of M2. Despite the acceleration of the broad money M2 growth during 2002, prices remained stable, along with a decline in currency in circulation and Ml growth. This result suggests that movements in M1 are better indicators than those in M2 to determine price changes, as M2 increase could be due to an automatic sterilization of the deposits of the state-owned oil company in the event of high oil prices given their “inactive” nature. Thus, such an increase would not put pressure on prices.

61. Nonmonetary factors have also an impact on price movements. Price movements are also affected, by a number of nonmonetary causes, the most fundamental of which being economic activity and weather conditions. The empirical test shows that economic activity and agricultural output influence price movements, although to a lesser extent than money supply.

62. The exchange rate is not a good predictor of short-term price changes in Algeria. The empirical work shows that, although the exchange rate has a long-term relation with inflation, it does not affect price changes in the short run. This could due to the combination of two factors: (a) the existence of a parallel market that might contribute to the explanation of the pass-through effect in the short term, although the lack of data prevents from confirming or infirming the existence of such relation, and (b) statistical weaknesses including the absence of data on tariff reduction that could have offset somehow the exchange rate effect.

63. Against this background, the 2002 price stability could be due to the combination of: (a) the deceleration of the currency in circulation and narrow money growths; and (b) the pick-up in the agricultural sector and the increase in output. The removal of trade barriers should have had an impact on the decline in inflation, however it has not been tested empirically due to data constraints.

64. Looking forward, Algeria’s experience highlights the need to conduct a prudent monetary policy on a sustained basis in order to avoid inflation, with currency in circulation and Ml being the variables that need closest attention. In this respect, a nonexpansionary fiscal policy constitutes an essential element in keeping inflation low.

65. These findings also shed some light on Algeria’s exchange rate policy. The fact that exchange rate movements have a mild impact on price changes in the short term may facilitate the move toward a more market-based determination of the exchange rate.

66. Finally, policies in favor of increasing total factor productivity would also help maintain price stability. The negative impact of economic growth and agricultural output on inflation suggests that structural and institutional reforms as well as infrastructural improvements to increase Algeria’s productive capacity will help maintain price stability.

APPENDIX I Definition of Variables

P = CPI = consumer price index

Pf = CPIf = CPI of main trading partners (euro area)

CCL= currency in circulation

M = money supply

M1 = narrow money (currency in circulation + demand deposits)

M2 = broad money (Ml + term deposits)

DC = domestic credit

CG = credit to the government

CE = credit to the economy

NEER = nominal effective exchange rate (a decline in NEER is equivalent to a depreciation)

REER = real effective exchange rate (a decline in REER is equivalent to a depreciation)

e = exchange rate (a decline in e is equivalent to an appreciation)

e$ = dinar/dollar exchange rate (a decline in e$ is equivalent to an appreciation)

eε = dinar/euro exchange rate (a decline in eg is equivalent to an appreciation)

Y= output

IMP = volume of imports expressed (used as a proxy for output)

CIMP = volume of cement imports

EPROD = electricity production

OILP = international oil prices

w = real wages

APPENDIX II Components of CPI Changes

APPENDIX III A Model-Based Unobserved Components Decomposition

This appendix describes the methodology used to decompose a series into its unobserved components. Briefly, the procedure is as follows: Let xt denote the original series and let

zt=δ(B)xt

represent the “differenced” series, where B stands for the lag operator, and δ(B) denotes the differences being taken on xt in order to achieve stationarity. We consider the case

δ(B)=ΔdΔsD

where Δd = 1- B and ΔSD = (1−B s)D represents the seasonal differencing of period s. The model for the differenced series zt can be expressed as:

Φ⁢(B)⁢(zt−z¯)=θ⁢(B)⁢αt

where z is the mean of zt, at is a white noise series of innovations, Φ(B) and θ(B) are autoregressive (AR) and moving average (MA) polynomials in B, respectively. This relationship can be expressed in a multiplicative form as the product of a regular polynomial in B and a seasonal polynomial in Bs, as in:

Φ(B)=Φr(B)Φs(Bs)Φ(B)=θτ(B)θs(Bs)

Substituting and rearranging, the complete model can be written in a detailed form as”

Φτ(B)Φs(Bs)ΔdΔsDx1=θτ(B)θs(Bs)αt+c

and in a concise form as:

Φ(B)xt=θ(B)αt+c

Where Φ(B) = Φ(B) θ(B) represents the complete autoregressive polynomial, including all unit roots. If p denotes the order of Φ(B) and q denotes the order of θ(B), then the order of Φ(B) is P = P + q + Dxs.

The decomposition into several components is done as follows: xt=∑ixit

where xit are the trend xpt seasonal xst, and irregular xut components. Broadly, the trend represents the long-term evolution of the series and displays a spectral peak at zero frequency; the seasonal component, in turn, captures the spectral peaks at seasonal frequencies. The irregular component captures erratic, white-noise behavior and hence, has a flat spectrum.

APPENDIX IV Statistics for ADF(2) Unit Root Tests

article image
Notes: Variables are as defined in Appendix I. For each variable expressed in level (first difference), the Augmented Dickey-Fuller (1979) ADF(2) statistics tests a null hypothesis of a unit root in that variable expressed in level (first difference) against an alternative, of a stationary root. The criterion for lag selection is based on the Akaike information criterion, as described by Pantula et. Al. (1994). The critical values are taken from MacKinnon (1991).*, and ** denote rejection at 5 percent and 1 percent critical values.

APPENDIX V Bivariate Granger Causality Tests

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P-values for the F-test of the null hypothesis that the indicator variable does not granger cause inflation beyond inflation itself.

APPENDIX VI Factors Influencing Inflation

APPENDIX VII Theoretical Model of Inflation

The following theoretical model provides the background to the empirical analysis on which variables should be used in determining inflation.

The general price level can be expressed as a weighted average of the price of tradable goods (PT) and nontradable goods (PN):

log⁡ Pt=θ(log⁡ PtN)+(1−θ)(log⁡ PtT)             where 0<θ<1                       (1)

The price of tradable goods is determined in the world market and depends on foreign price Pf and on the exchange rate (e). Assuming that purchasing power parity holds, PT can be depicted by the following expression:

log⁡PtT=log⁡ et+log⁡ Ptf(2)

As can be seen from (2), both an increase in the exchange rate and a rise in foreign prices will lead to an increase in domestic prices.

The price of nontradable goods is assumed to be determined in the domestic money market, where the demand for nontradable goods is assumed, for simplicity, to move in line with the overall demand in the economy. Accordingly, the price of nontradable goods is determined by the money market equilibrium condition, where real money supply ms (Mst/Pt) equals real money demand md  (Mtd​/PtN):

Log PtN=β(log⁡ Mts−log⁡ mtd)(3)

where β is a scale factor representing the relationship between economy wide demand and demand for nontradable goods. It is assumed that the demand for real balances is a function of real income, wages, interest rates, and inflationary expectations.

mtd=f(yt, wt, rt, E(πt))(4)

Expected inflation can be modeled in several ways. For simplicity, it is assumed to be determined by the inflation in the previous period:

E⁢(πt)=Δ⁢log⁡Pt−1(5)

The theory predicts that an increase in real income will lead to an increase in money demand, while an increase in interest rates or expected inflation will lead to a decrease in money demand. Substituting and rearranging results in the following estimable equation:

log⁡Pt=αlog⁡Mt++ϕlog⁡Yt−+σlog⁡wt++μ rt++δΔlog⁡ Pt−1++υlog⁡ et++γlog⁡Ptf++ut(6)

where ut is an error term, which is assumed to be normally distributed and of mean zero. Theory predicts that an increase in money supply, expected inflation, real wages, interest rates, the exchange rate and foreign prices will all drive prices up, while an increase in real income will lead to a decline in the inflation rate. The effect of sluggish adjustment due to rigidities and inertia can be captured by adding the effect of lagged prices to the equation.

APPENDIX VIII Results of Co-integration Test

article image
uA03app08fig01

Inverse Roots of AR Characteristic Polynomial

Citation: IMF Staff Country Reports 2004, 031; 10.5089/9781451811391.002.A003

uA03app08fig02

Cumulative Impulse Response to a One-Standard Deviation Shock

Citation: IMF Staff Country Reports 2004, 031; 10.5089/9781451811391.002.A003

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STATISTICAL APPENDIX

Table 1.

Algeria: Supply and Use of Resources at Current Prices, 1998–2002

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Source: Algerian authorities.
Table 2.

Algeria: Sectoral Distribution of GDP at Current Prices, 1998–2002

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Source: Algerian authorities.
Table 3.

Algeria: Sectoral Distribution of Real GDP Growth, 1998–2002

(In percent)

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Source: Algerian authorities.
Table 4.

Algeria: Production, Exports, and Consumption of Petroleum Products, 1998–2002

(In millions of tons)

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Source: Algerian authorities.

By-product of gas production.

Reflects change in inventories and errors of measurement.

Table 5.

Algeria: Production, Exports, and Consumption of Gas Products, 1998–2002

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Source: Algerian authorities.

Net of gas reinjected into producing oil wells.

Equal to net production minus gas flared, gas used for lifting and for fuel gas, and other losses in the fields.

Reflects errors in measurement.

Table 6.

Algeria: Domestic Prices of Major Energy Products, 1998–2002

(In dinars per liter; unless otherwise indicated)

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Source: Algerian authorities.
Table 7.

Algeria: Land Use Patterns, 1998–2002

(In thousands of hectares)

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Source: Algerian authorities.

Industrial tomatoes and tobacco.

Potatoes, tomatoes, garlic and onions, and watermelons.

Table 8.

Algeria: Crop Yields, 1998–2002

(In kilograms per hectare)

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Source: Algerian authorities.
Table 9.

Algeria: Livestock, 1998–2002

(In thousands of heads)

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Source: Algerian authorities.
Table 10.

Algeria: Index of Industrial Production in Public Enterprises, 1998–2002

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Source: Algerian authorities.
Table 11.

Algeria: Production of Minerals, 1998–2002 1/

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Source: Algerian authorities.

Excluding hydrocarbons.

In thousands of containers, each weighing 34 kilograms.