Drivers of Low Inflation in Malta after the Crisis
Despite robust growth, inflation in Malta has been subdued after the crisis and lower than what a Phillips curve would imply. This study examines the determinants of low inflation by comparing inflation forecasts conditioning on three groups of variables – real activity, external and financial – to see which one of these categories best explains post-crisis inflation. The analysis is conducted within a Bayesian VAR (BVAR) framework over two different disinflation periods, the first one starting in mid-2008 and the other one in 2012. For Malta, forecasts conditional on the path of the external variables are the closest to the actual path of inflation in both periods. On the contrary, in the euro area, the first episode was driven by external factors but domestic factors played a more important role in the second one. This point to the significant cross-country heterogeneity among euro area countries even in the face of apparently similar patterns in headline inflation.
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