| Summary: | This Selected Issues paper discusses the causes and implications of elevated inflation in Cyprus and describes recent inflation trends. The paper also analyses drivers of inflation in with an augmented Phillips Curve and investigates how wages adjust to inflation. Estimating a pass-through from inflation shocks to wages can further help assess domestic price pressures. Fiscal policies should help containing price pressures. While external developments drove inflation dynamics in 2022, domestic developments will increasingly determine inflation going forward. Given the historical pass-through, wage pressures are expected to intensify this year, aggravated by labor market tightness. Fiscal policy should hence support the battle against inflation, while protecting vulnerable households, which have been impacted disproportionally by the cost-of-living crisis. Spending plans in the 2023 budget are sufficiently tight to help contain inflation pressures from aggregate demand. Any upwards, revisions to the automatic cost-of-living allowance would risk sustaining high inflation and weakening the economy structurally
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