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Vugar Rahimov: Relationship between PPI and CPI in Azerbaijan: A Wavelet Approach

There is no consensus among researchers on the direction of causality between the
two variables. Although, majority of them suggest that the correlation between
producer prices and consumer prices is positive, and mainly the producer price causes
consumer prices (for example, Clark, 1995, Ghazali et al., 2018), there are studies
(Fan et al., 2009, Akçay, 2011) that have found the opposite causality suggesting that
the consumer prices affect producer prices.

The CPI inflation has been widely investigated from different perspectives in the
context of Azerbaijan (see for example, Rahimov et al., 2018, Niftiyev, 2020,
Rahimov et al., 2021 etc.). However, only a few studies have used producer prices as
a causing factor of consumer inflation. Therefore, it is also important to investigate
the relationship between producer prices and consumer prices. For that purpose, I
utilize wavelet analysis to examine the relationship between two variables. This
approach will allow me to conduct the study not only from time series perspective,
but also through frequency scale. A lot of studies have applied wavelet approach in
economic sciences to study a variety of relationships, as for example, Çepni et al.
(2020) for relationship between credit decomposition and economic activity, Jiang et
al. (2015) for relationship between money growth and inflation, Ramsey and Lampart
(1998) for relationship between money and income, Rua (2011) for forecasting
purposes etc.. In fact, Rua (2012) emphasizes that wavelet models can be considered
promising tool in economic studies as this approach is absent from drawbacks that
Fourier transforms possesses.

To best of my knowledge, this is the first paper that attempts to investigate the
relationship between PPI and CPI in Azerbaijan using a wavelet approach. The rest of
the paper is structured as follows. Section 2 is dedicated to a literature review, which
is followed by data and methodological issues, respectively. In section 5, the findings
are presented and discussed, and section 6 concludes.

LITERATURE REVIEW

The relationship between CPI and PPI has extensively and for long been examined in
literature. For example, Silver and Wallace (1980), applying Hatanaka-Wallace
procedure, try to identify lag relationships linking the consumer prices to producer
prices in the U.S. They find that there is one-sided lag structure (due to Sim’s test)
between the variables and producer prices are leading factor. However, two years later
Colclough and Lange (1982) find contrasting results for the U.S. producer and
consumer prices suggesting that the relationship is bidirectional.

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