Does the Domestic Output Gap Matter for Inflation in a Small Open Economy?

In this paper we investigate to what extent the behavior of consumer price index inflation depends on changes in domestic economic activity in Poland, which is usually described as a small open economy. We conduct a disaggregated analysis using the Phillips curve for individual price indexes. We find that more than 55 percent of the categories react to the output gap. According to our expectations, the categories most closely linked to the output gap are services and nondurable goods. We identify that only a small share of prices of durable and semidurable goods react to domestic demand, which can be explained to some extent by the globalization process. We also find that more than one-third of the price indexes respond to exchange rate movements-mostly durable and semidurable goods.