KVARTS - modelling of the Consumer Price Index

In this document, we provide an analytical decomposition of the Consumer Price Index (CPI) and outline how prices are determined in the KVARTS macroeconomic model. We use simulations performed with the model to analyse how changes in foreign prices and consumption taxes impact different measures of inflation. Four main conclusions emerge from our analysis. First, we find that the first-year effect on the CPI of a 1 per cent change in import prices is 0.4 per cent. Second, VAT and ad valorem excise tax rates have a much lower impact on inflation than excise taxes based on unit of sales. Third, most of the first-year impact of tax changes on the CPI is due to direct effects and not general equilibrium effects. Fourth, the CPI adjusted for taxes (CPI-AT) is also impacted by tax changes since excise taxes based on unit of sales are adjusted for CPI inflation.

Authors: Thomas von Brasch, Ådne Cappelen and Arnaldur Sölvi Kristjansson