What is Inflation?
This subsection explores the nature of inflation and how it is measured. It also covers the different measures of underlying inflation analyzed and used by the CBA, such as Core Inflation and Non-Traded Sticky Price Inflation (NTSPI), to better understand the inflationary environment and its underlying drivers.
Inflation is the general increase in prices of goods and services in an economy over time. Inflation means that consumers can buy fewer goods and services with the same amount of money. In general, inflation can occur when the overall demand for goods and services in the economy is higher than the overall supply. This can be caused by various factors such as changes in consumer demand, increased production costs, and so on. Inflation can also be caused by a rise in the price of imports, such as food or fuel.
Changes in the prices of individual products do not necessarily count as inflation. For any individual product, the price may fluctuate over time, for example, if there is very high demand for the product or if there are disruptions in the production of that product. This type of price change is known as a relative price change; that is, the price of that given product has increased relative to other prices. Inflation refers to the increase in the general price level of the overall basket of goods and services that is consumed by households. While moderate inflation is considered normal for a healthy economy, high or unstable inflation can have negative impacts, including reducing individuals' and businesses' ability to plan and make sound financial decisions. Central banks use monetary policy tools to manage inflation and maintain price stability for sustainable economic growth.
An important factor in economic planning is households’ and businesses’ perception of inflation today and expectations regarding future inflation. When they expect high inflation, households and businesses adjust their prices and wage demands accordingly. This creates a cycle of high price and wage increases, reinforcing the expectation of continued high inflation. On the other hand, when there is price stability, medium- and long-term inflation expectations are well-anchored to the inflation target. This creates a virtuous cycle: when expectations of future inflation are anchored around the inflation target, it becomes easier for the central bank to maintain price stability and minimize the costliness of monetary policy decisions.
How is inflation measured?
Inflation in Armenia is measured using the Consumer Price Index (CPI), which tracks price changes for a basket of goods and services commonly purchased by households. The Statistical Committee of Armenia is responsible for compiling and disseminating the official inflation numbers. Each month, the SC collects price data on goods and services included in the household consumption basket. Price changes are then included in the CPI, with greater weight given to items consumed on a larger scale. Annually, the SC updates the CPI basket to reflect changes in household income and consumption patterns.
Core Inflation
Both supply and demand factors can cause inflation to fluctuate, but supply-side inflationary effects often neutralize over time. Monetary policy typically focuses on demand-driven inflation and should not respond to transitory supply-side factors unless they affect inflation expectations. The primary focus of monetary policy is to respond to inflation that is caused by changes in aggregate demand conditions. In this context, we need to have reliable measures of inflation. In addition to the CPI, the CBA publishes and analyzes different measures of core inflation. These core measures enable us to have a more comprehensive understanding of aggregate demand-driven factors. Additionally, these measures reduce the noise coming from price changes that are driven by supply-side factors.
Non-Traded Sticky Price Inflation
The CBA analyzes and publishes Non-Traded Sticky Price Inflation (NTSPI), a measure of inflation for non-traded items with prices set infrequently, (e.g. apartment rents, haircut prices, etc.). When businesses change these prices, they factor in expectations of future inflation, as they cannot quickly adjust prices if economic conditions change. Therefore, these "sticky" prices include some component of inflation expectations and provide insight into current demand conditions and inflation expectations. By focusing on non-traded goods, NTSPI avoids the noise from traded goods, which can be influenced by factors like exchange rate fluctuations and supply chain disruptions, offering a more reliable indicator of generalized excess demand pressures.
Current Inflation Rate
From the perspective of monetary policy, the CBA targets year-over-year CPI inflation. This is defined as the change in the CPI inflation in a specific month compared to the same month of the previous year (also known as 12-month, or year-over-year inflation).