Globalization, market structure and inflation dynamics

Abstract

The decline in the sensitivity of inflation to domestic slack observed in developed countries since the mid 1980's has been often attributed to globalization. However, this intuition has so far not been formalized. I develop a general equilibrium setup in which the sensitivity of inflation to marginal cost decreases when international trade costs fall. In order to do so, I add three ingredients to an otherwise standard two-country new-Keynesian model. Strategic interactions generate a time varying desired markup; endogenous entry and heterogeneous productivity engender a self-selection of the most productive firms (also the largest ones) in international trade. Hence the weight of large firms in domestic production increases. These firms transmit less marginal cost fluctuations to price adjustments, rather absorbing them into their desired markup in order to protect their market share. At the aggregate level, domestic inflation reacts less to real activity fluctuations.

Prices and Inflation in Global Value Chains : A global inflation-to-output price elasticity database with applications

“…Another strand of the literature links imported inflation with exchange rate volatilities and price shocks generated by them (Bems and Johnson, 2017;Camatte et al, 2020Camatte et al, , 2021. Some other papers perform a complex quantity, price, inflation, and monetary policy modelling in a global value chain context using mainly two-or three-country (or -region) small-open economy New Keynesian dynamic stochastic general equilibrium (DSGE) models (Wei and Xie, 2020;Guilloux-Nefussi, 2020;Khalil, 2022).…”

“…In this paper we do not address monetary policy issues but focus only on input price determinants of global inflation assuming stable exchange rates as our analysis is based on inputoutput price and inflation elasticities. The concept of elasticities in general is well-known in the IO (Angel Tarancón et al, 2008;Karasz, 1992;Maass, 1980;Mattas and Shrestha, 1991;Schnabl, 2003;Felice and Tajoli, 2021;Timmer et al, 2021) and international economics (Bems, 2014;Auer and Schoenle, 2016;Guilloux-Nefussi, 2020) literature. Based on the representation of output-to-output multipliers and elasticities in Leontief quantity model by Miller and Blair (2009) we introduce the concept of output price-to-output price elasticities and derive them in both Leontief and Ghosh cost-push price models.…”