Inflation thresholds and oil shock transmission in the UK: a self-exciting threshold VAR approach

By Andrew Gaffney, Katerina Petrova, Galina Potjagailo and Andrea Sisko

This paper identifies inflation thresholds and analyses state-dependent inflation dynamics in the UK using a Self-Exciting Threshold Vector Autoregression (SET-VAR). The model combines endogenous threshold estimation with regime-dependent shock transmission, providing a tractable tool for analysing non-linear inflation dynamics. We illustrate how the approach can be used to analyse the transmission of global oil supply shocks and conduct counterfactual simulations to quantify the role of expectations in amplifying inflationary effects. Further, within each identified inflation regime, we examine how shock transmission differs between periods of tight and slack labour markets. Using monthly UK data, we find that inflation dynamics change once year-on-year CPI inflation rises above thresholds of around 3.1% and 3.5% in samples beginning in 1989 and 1976, respectively. Oil price increases generated by adverse global oil supply news shocks have substantially larger and more persistent effects on UK CPI inflation in high-inflation regimes. Counterfactual analysis indicates that much of this amplification reflects second-round effects operating through household inflation expectations, with amplification strongest when elevated inflation coincides with tight labour markets.

Inflation thresholds and oil shock transmission in the UK: a self-exciting threshold VAR approach