Findings Indicate That Improvement in Household Inflation Expectations Will Also Support the Disinflation Process Through Supply-Side Factors - Central Bank of the Republic of Turkey Blog Post
According to a recent blog post on the Central Bank of the Republic of Turkey (CBRT) website, the findings indicate that the recent improvement in household inflation expectations will support the disinflation process not only through demand but also through supply factors.
The blog post titled "Household Inflation Expectations and Service Inflation," written by CBRT Assistant Economist Barbaros Eriş and Expert Ahmet Duhan Yassa, elaborates on this matter.
The article continues: "Success in combating inflation is closely related to improvements in household inflation expectations and service inflation. While the recent improvements in household inflation expectations have occurred with a lag compared to market participants, the rigidity in service prices has also been a factor slowing the decline in inflation (Graphs 1 and 2). This article examines the supply-side relationship between household inflation expectations and actual service inflation.
Economic literature suggests that there may be a pass-through from actual inflation to household inflation expectations. Particularly, price increases for products such as food and fuel can raise household inflation expectations further. On the other hand, high inflation expectations also play a role in determining actual inflation. Household inflation expectations can influence goods and services inflation from the demand side as a factor that increases consumption tendencies. Moreover, this bidirectional relationship between expected and actual inflation reflects not only demand-side effects but also supply-side effects due to households being part of the supply segment for certain services. For instance, households have the power to determine prices for services such as domestic services, hairdressing, and photography by providing them directly. Therefore, supply-side factors may also influence the relationship between household inflation expectations and actual service inflation.
To examine supply-side effects, we classify household-provided services, such as domestic services or barbering, as services offered by this segment. Within this classification framework, it has been observed that inflation in services provided by households has been higher than both the CPI index and the service CPI index in recent years (Graph 3). From January 2020 to November 2024, the price index for services provided by households has increased by 21% compared to the general CPI and approximately 11% more than the service CPI index.
When this divergence in price increases is analyzed in detail, it is closely related to household inflation expectations. Indeed, during periods when the sectoral difference in household inflation expectations trends upward, relative prices of services provided by households compared to other service products also increase (Graph 4). This situation implies that households reflect their deteriorating inflation expectations onto the prices of the services they provide.
When we econometrically test the existence of this relationship, we obtain results that confirm our preliminary findings. Our findings indicate a positive relationship between the inflation of services provided by households and household inflation expectations (Graph 5). According to the regression results, following a 10% increase in the difference between household and market inflation expectations, a monthly inflation increase of 0.42 percentage points, or 42 basis points, is observed in services provided by this segment compared to all other products (CPI) in the following month. Additionally, the results show that this relationship is not limited to periods of wage increases. When excluding periods of wage increases, a 10% deterioration in inflation expectations implies a monthly inflation increase of 24 basis points in those services compared to all other products. When evaluated exclusively concerning service products, this indicates a monthly inflation of 19 basis points.
In summary, the findings suggest that high household inflation expectations are one of the determinants of price rigidity in the services provided by households. Consequently, our findings indicate that the recent improvement in household inflation expectations will support the disinflation process not only through demand factors but also through supply factors.