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STU 02-98 : Special Topic - Explaining consumer price inflation [Short Term Update 02-98]

Growth in Belgium in 1997 turned out significantly better than expected, but some weakening has occurred during the last quarter. The underlying trend in GDP growth should, however, confirm the 2.5% growth forecast for 1998.

The weakening in growth activity at the end of last year is to a large extent due to a significantly lower rate of growth for exports. As has been mentioned in other FPB-publications, the Asia crisis is having a dampening effect on the world and also the Belgian economy. The impact of the Asia crisis will mainly be felt in trade. Export growth will, therefore, continue to be negatively affected by slower growth in world trade. Price competitiveness has, on the other hand, improved considerably during the last two years. All in all, net exports should continue to make a positive contribution to GDP growth, but this contribution will be smaller than in 1997. As the effect of the Asia crisis is expected to be limited to 1998, some increase in growth is again expected in 1999 with GDP growth of 2.8%.

Domestic demand and particularly private consumption have continued to show a marked improvement. The consumer confidence index, strengthened by the creation of considerable employment opportunities, somewhat higher wage increases and good news concerning public finance, points to sustained consumer growth during the first quarters of 1998.

The medium-term outlook for Belgium points to an average growth rate of 2.6% over the next five years. But even with this rate of growth and moderate wage increases in accordance with the 1996 Framework Law, unemployment is likely to remain above the 1990 level. The growth in employment is estimated at around 0.75% per year and the supply of labour would increase by 0.2% per year.

The general government borrowing requirement should continue to show a gradual decrease and become a surplus from 2002 onwards in an “unchanged policy” scenario. The primary surplus should remain close to 6% from 1997 to 2000 and should increase again from then on. The debt ratio and interest burden are clearly decreasing.

Consumer price inflation should remain at 1.1% this year and show only a slight increase next year. If there are no external shocks and if wages continue to be constrained by the Competitiveness Law, there are few reasons why price stability should be threatened in future. Nominal interest rates should remain low.


In recent years, the fall in consumer price inflation has been considerable. There are a number of reasons for this. An increasingly global and competitive economy has resulted in a decrease in world-wide inflation, leading to lower import prices. Primary commodity prices have fallen considerably. Wage moderation policies have been followed in many countries in Europe, perhaps linked to an attempt to fulfil the monetary Maastricht criteria. Moreover, central banks in many countries have increasingly concentrated on the objective of price stability. Finally, the existence of negative output gaps in recent years have protected many economies against inflationary pressures. In order to be able to assess inflation and its determinants correctly, attention should be focused on underlying inflation.

Underlying inflation

Short-term price movements are sometimes rather erratic, temporary and/or difficult to forecast. Underlying inflation (often also called core inflation) tries to measure fundamental price movements. Some specific categories of goods such as energy products, tobacco, alcoholic drinks, fresh fruit and vegetables are excluded as well as indirect taxes on other products. Compared with observed inflation, underlying inflation is more stable and should bear a closer relationship to the economic fundamentals.

Inflation and indirect taxes

First, attention must be paid to one factor which explains the unstable behaviour of observed inflation, namely indirect taxes. An index of consumer prices exclusive of indirect taxes is established for the period January 1984 - December 1997. Value added taxes (VAT), excises (on fuel, alcoholic drinks and tobacco products) and some other special taxes are regarded as indirect taxes. Graph 2 compares the yearly average growth rates of both indices and presents the overall indirect tax rate 3 on private consumption.

Two causes of changes in the overall indirect tax rate can be distinguished. Most obviously, the overall indirect tax rate changes when excises, VAT rates or other indirect tax rates are modified. Secondly, as the tax base for excises is not linked to prices, the indirect tax rate also changes when prices exclusive of excises change, even with unaltered excise duties. Indirect tax pressure, for instance, is negatively correlated to world oil prices expressed in Belgian francs.

Between 1984 and 1986, legal indirect tax rates have not been modified. Up to the middle of 1985, the fall in the overall indirect tax rate can be almost wholly attributed to the massive appreciation of the American dollar, which has led to higher fuel prices in Belgian francs. During the next six quarters, the overall indirect tax rate rose by more than 1% point, mainly due to the strong depreciation of the American dollar and the fact that the Brent oil price almost halved.

In 1987 and 1988 legal indirect tax rates were again not modified, and the dollar and the oil prices were relatively stable. As a result, the overall indirect tax rate remained almost level.

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