Findings Indicate That Improvement in Household Inflation Expectations Will Also Support the Disinflation Process from Supply-Side Factors - TCMB Blog Post
In a blog post on the Central Bank of the Republic of Turkey (CBRT) website, it was stated that the recent improvement in household inflation expectations indicates that the disinflation process will be supported not only by demand-side factors but also by supply-side factors. The blog titled "Household Inflation Expectations and Service Inflation" was authored by CBRT Assistant Economist Barbaros Eriş and Specialist Ahmen Duhan Yassa.
The article continued as follows: "Success in combating inflation is closely related to the improvement in household inflation expectations and service inflation. The recent improvement in household inflation expectations occurred later than what market participants experienced, while the rigidity in service prices has also been a factor slowing down the decrease in inflation (Graphs 1 and 2). In this article, we investigate the supply-side relationship between household inflation expectations and the actual service inflation.
Economic literature suggests that there may be transitivity from actual inflation to household inflation expectations. Particularly, price increases in items such as food and fuel can further elevate household inflation expectations. On the other hand, high inflation expectations are also a determinant of actual inflation. Household inflation expectations can influence the inflation of goods and services in a demand-oriented manner. Moreover, this dual relationship between expected and actual inflation reflects supply-side effects as households are the providers of certain services. For instance, households can directly provide services such as domestic services, hairdressing, and photography that are included in the CPI basket, thus possessing the power to set prices for these items. Therefore, supply-side factors can also be influential in the relationship between household inflation expectations and actual service inflation.
To examine supply-side impacts, we classify the domestic services provided by households or tradesmen such as hairdressing as services supplied by this segment. In this classification, it is observed that inflation in services provided by households has been higher compared to both the CPI index and the service-CPI index in recent years (Graph 3). Between January 2020 and November 2024, the price index of services offered by households increased by 21% compared to the overall CPI, and approximately by 11% compared to the CPI-service index.
A detailed examination reveals that this divergence in price increases is closely related to household inflation expectations. Indeed, during the periods when there is an upward trajectory in the sectoral differences in household inflation expectations, relative prices of services provided by households compared to other service products also rise (Graph 4). This situation implies that households are reflecting 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 show a positive relationship between the inflation of services provided by households and household inflation expectations (Graph 5). According to regression results, following a 10% increase in the difference between household and market inflation expectations, there is a 0.42 point or 42 basis point monthly inflation increase in the services provided by this segment compared to all other products (CPI) in the following month. Additionally, the obtained results indicate that this relationship is not exclusive to periods of wage increases. Excluding periods of wage increases, a 10% deterioration in inflation expectations implies a monthly inflation increase of 24 basis points in the following month for these services compared to all other products. When this relationship is considered solely for service products, it indicates a monthly inflation of 19 basis points.
In summary, the findings suggest that high household inflation expectations are one of the determinants of rigidity in service prices through the channel of services provided by households. Therefore, our findings indicate that the recent improvement in household inflation expectations will support the disinflation process not only from the demand side but also from the supply side."