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Theoretical and Applied Economics
No. 3 / 2015 (604), Autumn

Is CPI a suitable tool for inflation targeting? A critical view

Necmettin Erbakan University, Turkey
Muhsin KAR
Necmettin Erbakan University, Turkey
Gaziantep University, Turkey

Abstract. Since Frankel (2011, 2012) criticizes the choice of consumer price index as a policy index for its adverse impacts on the output in the developing economies, economists suggest different policy proposals in order to stabilize price level. One of them is to change price index in measurement of inflation. In this study, we investigate the suitability of an alternative price index in inflation targeting regime instead of consumer price index in Turkish economy. In this regard, we employ the producer price index instead of consumer price index in order to investigate the suitability of Frankel’s policy proposals. The empirical results, obtained from conventional VAR analysis suggest that the impact of producer price on the inflation rate is in the short term and it is weak. Similarly, MS-VAR analysis by utilizing the monthly data for the period 2003M2 - 2013M6, show that there is not a significant impact of producer price on the inflation rate during the expansionary period and it is also possible to talk about the effect of supply side shocks in the recession regime. Therefore, the consumer price index seems to be an appropriate instrument to target inflation rate, but the producer price index should also take into account to target inflation during the recessionary period in Turkey.

Keywords: Inflation targeting, CPI, PPI, MS-VAR.

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