The effect of imported EU inflation on Macedonian inflation – a cointegration approach

Abstract

Inflation has become one of the most important challenges in a world that is still recovering from the pandemic, and it is suffering the consequences from the conflict between Ukraine and Russia. Pandemic restrictions, bottleneck pressures in supply chains, jump in energy prices – these are all causing the inflation to rise, and slowing the recovery of many economies globally. This paper investigates the foreign drivers of national inflation using the cointegration approach and the Vector Error Correction Model. It tends to prove that there is long-term relationship between the national inflation and the inflation in the European Union. This is understandable, having in mind that North Macedonia is small and open economy, dependable on imports of food, energy, and other products. The impulse response function estimated in the model confirm that shocks in EU inflation have significant and long-term implication on the national inflation. The effect from the shock starts in the first month and it pertains throughout the observed period of 12 months, reaching its maximum of 0.7315 percentage points. This is a clear indicator that every shock that occurs in the inflation in the European Union almost immediately transfers to the national inflation. Forecasts of the model predict steady increase in the national inflation rate, ending the year 2022 with 14.8%. The existence of this relationship should be important guideline to policy makers, who should be aware of the significant foreign impact. They should create appropriate and timely policy consisted of monetary, fiscal, social, and other measures that could fight the rising inflation in more effective manner.