TUNESS Chart of the Week
(05/06/2013)
In this weekly note, we shed some light on the dynamic of the inflation rate in Tunisia. At first glance (figure 1), it seems that the inflation rate in Tunisia has constantly moved during the period under investigation within a range of 2 to 6 % with a peak during the year 1995 when the government adopted a series of economic policies to ensure greater openness of the Tunisian economy to the global market along with gradual liberalization of the domestic financial markets.
Although this financial liberalization era (that has caused a growing inflationary pressure in the country) was followed by relatively stable economic conditions where price levels were kept under control (not exceeding a reasonable level of 3 %), starting from 2001 the inflation rate began once again trending upward albeit in a cyclical fashion. This high volatility of the price levels tends to introduce, according to the economic theory, an additional uncertainty element into the economic environment of the country and thus reduce the ability of the domestic and international actors to formulate accurate expectations about future trends of macroeconomic variables. Investors are often extremely reluctant, in this kind of unpredictable environment, to finance long-term projects, limiting the country’s long run development perspectives.
In this note, we focus on the influence of the external shock generated by a depreciation of the exchange rate (following the recent depreciation of the Tunisian dinar) on the short run dynamic of the price level. We use the impulse response function of the Tunisian price level to exchange rate shock (figure 2) to better comprehend the transmission mechanisms through which the inflation rate react to the recent shock.
As can be seen in figure 2, an exchange rate shock leads to an instantaneous, albeit marginal, variation of the inflation rate in the first year before it gets muted thereafter. This instantaneous impact of external shock should come with no surprise since the tradable goods represent an important component of the country’s import basket. The impact of the exchange rate shock on the price level is assumed to be offset over time by the variance of the aggregate demand as real wages in the economy start to adjust to the resulting inflation variance after two quarters from its occurrence. We interpret the persistent variance of the inflation rate following the exchange rate shock as the result of a continuous intervention of the monetary authority to offset the impact on the price level by calibrating various parameters of the economy. The long run equilibrium is only reached after 18 months.
Based on our analysis, we expect the current upward movement of the inflationary pressure to maintain its trend at least over the next 5 to 6 months. The monetary authority will be then inclined to take necessary measures to mitigate those pressures through an incremental increase of its main monetary policy instrument, i.e., interest rate. This action could in return slow down the economic activity in the country which is currently experiencing tremendous difficulties to take off.
This note is prepared by TUNESS Research Team.
Data source: IMF, Author calculation.