Globalisation and OECD consumer price inflation

Abstract

Over the past 25 years inflation has moderated considerably in all OECD economies. At the same time, the production of many goods and services has become increasingly internationalised and the level of trade between the OECD and non-OECD economies has risen markedly. This paper investigates the extent to which the observed changes in the inflation process can be attributed to the increasing integration of non-OECD economies into the global economy. The results of the analysis show that i) import prices have become a more important driver of domestic consumer prices since the mid-1990s; ii) the sensitivity of inflation to domestic economic conditions has declined whereas the sensitivity to foreign economic conditions has risen, working through import prices; and iii) the strong GDP growth in the non-OECD economies over the past five years has contributed to the growth of real oil and metals prices. A scenario analysis shows that globalisation has put upward pressure on inflation via higher commodity prices and downward pressure via lower non-commodity import prices with the latter effect having dominated in most OECD economies.

Globalisation Effect on Inflation in the Great Moderation Era: New Evidence from G10 Countries

“…When it comes to econometric model results, however, the evidence is inconclusive concerning the hypothesis of whether globalisation has indeed significantly contributed to the inflation dynamics of these economies. For example, while supportive evidence are presented in Pain et al (2006Pain et al ( , 2008, Borio and Filardo (2007), Pehnelt (2007), Wang and Wen (2007), and also partially in Ciccarelli and Mojon (2010), negative results are reported by Ball (2006) and Ihrig et al (2010).…”

“…Besides, the limit of our attention to the Great Moderation era should help reduce the risk of significant parameter shifts. Specifically, we postulate an alternative model to (1) by introducing a trade-ratio based openness index, O it r , as a measure of increasing import penetration, similar to what Pain et al (2006Pain et al ( , 2008 and Ihrig et al (2010) have done: Other variations of (2) should also be possible depending on which parameters in (1) are potentially most susceptible to trade-induced shifts. For example, Pain et al (2006Pain et al ( , 2008 only consider the case of weighted long-run parameters, ie: (2) with different mixture of weighted explanatory variables, for example, one with only the short-run variables weighted and another with only the long-run variables weighted.…”

“…One theoretical weakness of the type of Phillips curve models is the absence of explicitly specified long-run disequilibrium effect on the inflation dynamics. The long-run effect is included in the form of an error-correction term in the models by Pain et al (2006Pain et al ( , 2008. We shall follow their step.…”

“…The wage index is used as a proxy of domestic costs, eg see Pain et al (2006Pain et al ( , 2008. Obviously, it is impossible to rule out any foreign impact on wages, as pointed out by Ihrig et al (2010).…”

“…The resulting simplified models are (2006), Melick and Galati (2006), Pain et al (2006Pain et al ( , 2008, White (2008) and Bean (2010). The only aspect that we want to emphasise here is that there is a visible increase of cross-country correlations in inflation since the late 1990s (see Table 1), especially compared to the cross-country wage rate correlations shown in Table 2, and that the increase is coupled with an increase in the cross-country import prices, as shown from Table 3.…”