Heterogeneous Response of Disaggregate Inflation to Monetary Policy Regime Change: What Can Be Learned from Canada’s Adoption of Inflation Targeting?

42 Pages Posted: 18 Apr 2012

See all articles by C. Y. Choi

C. Y. Choi

University of Texas at Arlington - College of Business Administration - Department of Economics

Roisin O'Sullivan

Smith College - Department of Economics

Date Written: March 31, 2012

Abstract

This paper explores the impact of monetary policy regime change on sectoral and regional inflation by analyzing the case of Canada and its adoption of inflation targeting (IT). Using disaggregated CPI data for Canada from 1978, we find that responses to the change in the monetary policy framework are quite heterogeneous, particularly across sectors. While inflation series in the traditionally volatile commodity sectors exhibit weak responses to the regime change, those in the so-called core sectors are highly responsive. This pattern is evident in both national and provincial level data, indicating that it is the core sectors that are crucial for the transmission of a monetary policy regime change. Further analysis based on a common factor model reveals that common shocks, such as those associated with the monetary policy framework, account for only a small portion of the variation in sectoral inflation, and that their relative importance has decreased after IT adoption in many core sectors. Interestingly, considerable variation exists even across the core sectors in the strength of the regime change effect. We document that this heterogeneity is meaningfully correlated with some measurable sector-specific characteristics; sectors with a lower degree of prices stickiness and a lower degree of tradability appear more sensitive to the change in monetary policy regime.

Suggested Citation

Choi, Chi-Young and O'Sullivan, Roisin, Heterogeneous Response of Disaggregate Inflation to Monetary Policy Regime Change: What Can Be Learned from Canada’s Adoption of Inflation Targeting? (March 31, 2012). Available at SSRN: https://ssrn.com/abstract=2041206 or http://dx.doi.org/10.2139/ssrn.2041206

Chi-Young Choi (Contact Author)

University of Texas at Arlington - College of Business Administration - Department of Economics ( email )

Box 19479 UTA
Arlington, TX 76019
United States

Roisin O'Sullivan

Smith College - Department of Economics ( email )

Northampton, MA 01063
United States

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