An input-output based measure of underlying domestic inflation in Denmark 1903-2002

The paper analyses the development in inflation in Denmark during the last century. New annual input-output based time-series data for the underlying domestic inflation in Denmark 1903-2002 is constructed by stripping the development in the private consumption deflator for price increases caused by the direct and indirect content of imports, indirect taxes and gross rents. The analysis seems to suggest that an input-output based underlying inflation measure paints a fundamentally different picture of the inflationary development than the private consumption deflator in periods with large structural movements in the relative prices or periods with high inflation volatility. The most marked example is the period 1973-1986 characterised by large increases in indirect taxes and gross rents as well as a high and volatile element of imported inflation due to large oil price movements as well as large and frequent devaluations of the Danish krone. A low level of input-output based underlying inflation does not necessary imply a low future level of inflation. The input-output based measure of underlying domestic inflation reflects the development in wages and gross profit per produced unit in domestic goods and services delivered for private consumption. A temporary drop in the level of underlying inflation, e.g. around the second oil-price shock, may therefore partly reflect a temporary squeeze of profit margins that later gets restored. An input-output based underlying inflation measure may however provide insights into the inflation process that can not be easily uncovered from other economic indicators. An inputoutput based measure of the underlying inflation can be a useful supplement to other types of information (e.g. the development in wages, output gap etc.) in relation to both an interpretation of the historical inflation development and as an input into a broad assessment of the current inflationary environment. Despite the relatively comprehensive calculation procedure input-output based measures of underlying inflation may therefore add value to the arsenal of other core-inflation indicators used within the central-banking community.