Inflation: Demand Pull or Cost Push? A Markov Switching Approach

Abstract In this paper, we develop a Markov switching method to quantify the relative contributions of cost-push and demand-pull to current inflationary pressures. This approach aids in studying whether the inflation is short-lived or more persistent. We apply this method to Australian data and identify three episodes in the last 25 years when the inflation rate exceeded 4 %. All three episodes were primarily driven by cost-push factors. Our results reveal that monetary policy is more effective in controlling demand-pull inflation but less so in controlling cost-push inflation. This observation explains why the episodes of relatively higher inflation were predominantly driven by cost-push factors. Furthermore, we contrast our findings with US inflation drivers.