Revisiting inflation inertia: A comprehensive analysis of dynamics and connectedness in the Turkish case

Abstract

This paper examines the phenomenon of inflation inertia in Türkiye focusing on its persistence and the role of interconnected price-setting behaviors. Utilizing monthly data from 2004 to 2024, the study applies a novel augmented Phillips Curve framework, integrating a Time-Varying Parameter (TVP) approach with a connectedness measure derived from the Antonakakis et al. (2020) methodology. Our aim is to investigate the interplay between consumer price inflation and sub-level pricing dynamics to understand how interconnectedness amplifies inflation persistence. This study uniquely contributes to the literature by analyzing inflation inertia alongside the influence of commodity price interconnectedness, offering a dual perspective on inflation dynamics. The findings reveal a marked increase in inflation inertia in Türkiye since 2018, driven by stronger inflation expectations and intensified price interconnectedness, particularly after 2022. The results underscore the compounded impact of synchronized pricing adjustments and sectoral linkages in perpetuating inflation persistence, which hinders the effectiveness of conventional monetary policy. Robustness checks by employing Markov Switching Regression (MSR) models, the quantile-on-quantile (QQ) regression and causality results confirm these dynamics. Policy recommendations emphasize the need for a coordinated approach, integrating monetary, fiscal, exchange rate, and income policies to reduce system-wide price interconnectedness. Central banks must adopt a clear and credible policy horizon to break inflationary expectations and mitigate inertia. By addressing these systemic challenges, policymakers can enhance the efficacy of inflation-targeting frameworks, supporting sustainable price stability in the face of entrenched inflation dynamics.