MONETARY POLICY REPORT | SPRING 2024 (box 2)
(authors: Jan Šolc, Natálie Tomanová)
After the period of high inflation that gripped the Czech economy for around two years starting in mid-2021, the situation started to calm during 2023, with inflation returning to the CNB’s 2% target in 2024 Q1. This box examines inflation in two important categories of consumer basket items – prices of services and prices of goods within core inflation – in terms of the pace, breadth and persistence of the price changes in these categories.
From the long-term perspective, services inflation was higher than goods inflation until 2019. A significant change occurred during the Covid period, when a lot of services became unavailable due to shutdowns of many businesses for epidemiological reasons, forcing a partial shift in demand from services to goods. This, along with value chain disruption, resulted in long-unseen convergence of services inflation and goods inflation, which remained at comparable levels until autumn 2021. The situation was exacerbated by a further shock, this time a surge in energy prices at the end of 2021, which escalated after Russia’s invasion of Ukraine in February 2022. Growth in energy prices traditionally affects goods prices more strongly, so the previously observed only modest gap between services and goods inflation swung significantly in the opposite direction. In recent months, the gap has turned positive again and returned close to its long-term average as these factors have faded (see Chart 1).
Chart 1 – The current gap between goods and services inflation is in line with the long-term average
year-on-year growth in prices in %; gap in percentage points; CPI; adjusted for tax effects; source: CZSO, CNB calculations
A comparison of the Czech economy with other countries[1] (see Chart 2) reveals that in the past the gap between services and goods inflation in the Czech Republic was similar to that in Poland and Slovakia and markedly higher than in Germany and the euro area.[2] It was visibly positive on average in 2006–2019, at around 3 pp. However, during the Covid period and at the start of the high-inflation episode, the domestic trend diverged from the rest of the converging economies and was more in line with the situation in Germany and the euro area, where the gap turned negative – like it did in the Czech Republic after the energy crisis (see above). In mid-2022,[3] however, the gap in the Czech Republic turned positive again, rising briskly until mid-2023. Since then, it has stayed broadly stable at an elevated level. An upward trend has also been evident in all the other economies under review except Slovakia in recent months, while in Poland and the euro area – like the Czech Republic – the gap is currently above the average for 2006–2019.
Chart 2 – The gap between services and goods inflation has long been markedly wider in converging economies
gap between services and goods inflation in percentage points; dotted lines indicate averages in given countries for 2006–2019; HICP; source: Eurostat
It is evident from the data for 2024 Q1, too, that domestic prices of services are rising faster than prices of goods[4] (see Chart 3). The increase in services prices was quite broad-based. For most services items (around 80%), prices went up more than the overall average for this category of the consumer basket, as higher-weight items slightly dampened the overall growth in services prices. This was particularly true for imputed rent (the largest light-blue dot in Chart 3), whose growth lagged behind its long-term average in 2024 Q1. Its contribution to inflation can be expected to increase again due to the current recovery in the property market. The growth of the individual items in the goods category is more dispersed. As regards inflation persistence,[5] the higher-weight services items (such as prices in restaurants) tend to show greater persistence of price changes. Some high-weight items in the goods category (such as prices of garments) also show relatively strong persistence.
Chart 3 – The current services inflation is being driven by most items and dampened mainly by imputed rent; the growth in prices of goods items is more dispersed
x-axis: inflation persistence of items; y-axis: average month-on-month growth in 2024 Q1 in %; seasonally adjusted; size of bubble corresponds to weight of item in consumer basket; blue: services items, red: goods items; horizontal lines: average month-on-month growth in 2024 Q1 for services (blue) and goods (red); dark (light) shade of bubble: current pace of growth is above (below) historical average for 2010–2019; source: CZSO, CNB calculations
To sum up, after the pandemic period, when prices of services increased more slowly than prices of goods, the gap between their growth rates in CPI terms is returning to its long-term (positive) average. The gap is in line with the historical norm and is not anomalous in the international context either (in HICP terms). However, the uncertainty regarding the further slowdown in services inflation is associated mainly with the fading of the currently low contribution of imputed rent in a recovering property market.
[1] For the international comparison, data from the Harmonised Index of Consumer Prices (HICP) were used, for which the definition of goods and services differs slightly from the CPI. The main difference is that imputed rent is not included in services in the HICP.
[2] A strongly positive growth differential between prices of services and goods is typical of converging economies and is referred to in the literature as the Balassa-Samuelson effect. This phenomenon is reflected in the forecast by the contribution of price convergence to marginal costs in the consumer sector. In addition to the long-term Balassa-Samuelson effect, the reason for the higher growth in prices of services than goods may be the greater weight of the still rapidly growing labour costs in the production of non-tradables. Greater pricing power of companies – due to the fact that in local markets service providers are often pseudo monopolies and there are often strong personal ties between providers and customers (especially in smaller towns) – may have the same effect. Consumers are therefore willing to accept higher prices (stronger price growth), as they are de facto putting money into the pockets of their “neighbours” (not international firms), which thus increases profit margins. Last but not least, the redirection of part of households’ consumption expenditure from goods back to services in the period of the post-Covid reopening of the economy, services, entertainment and travel and the resulting general euphoria, also had some effect.
[3] By then, growth in imputed rent had started to slow significantly, so the negative gap between services and goods inflation in national CPI terms conversely began to widen even more.
[4] The analysis focuses on around 80 goods and services items in the consumer basket which together make up core inflation. These items combined account for more than 50% of the consumer basket.
[5] Persistence is defined as the sum of the first three coefficients of the partial autocorrelation function on the seasonally adjusted month-on-month price changes. Persistence indicates the extent to which an observed movement in prices remains at the level attained.