Understanding UK Inflation: The Role of Openness

The Global Dimension of Inflation - Evidence from Factor-Augmented Phillips Curves

“…In this respect, we do justice to those who criticize the literature which includes foreign output gaps in Phillips curve equations and who argue that foreign demand conditions should affect domestic inflation through their effect on the domestic output gap or 1 Positive effects of import price inflation on domestic inflation are found by Balakrishnan and López-Salido (2002) for the UK, Galí and López-Salido (2000) for Spain, Gamber and Hung (2001) Ihrig et al (2007), Gerlach et al (2008) and Batini et al (2005) show that these results are not robust. 2 While Balakrishnan and Lopez-Salido (2002) and Mody and Ohnsorge (2007) find a significant impact of changes in the terms of trade and the nominal effective exchange rates on inflation in the UK and in 25 members of the European Union, respectively, Batini et al (2005) shows that real oil price inflation does not robustly affect inflation in the UK across specifications. The latter authors also find that foreign competition significantly lowers inflation in the UK in only one out of six specifications.…”

“…Borio and Filardo (2006), Ihrig et al (2007), Pain et al (2006), Mody and Ohnsorge (2007), Gerlach et al (2008), Ball (2006), IMF (2006), Calza (2008, Gamber and Hung (2001), Tootell (1998) apply traditional Phillips curve frameworks to panels of developed countries or individual developed countries. Batini et al (2005), Balakrishnan and Lopez-Salido (2002), Galí and Lopez-Salido (2002), Razin and Yuen (2002), Gadzinski andHoffmann (2008), Calza (2008), Dées et al (2008), Leith and Malley (2007) and Rumler (2007) all employ New Keynesian setups. Borio and Filardo (2006) find positive and significant effects of foreign output gaps on domestic inflation between 1985 and 2005 in almost all 15 industrial countries they consider (an exception being Germany) and the euro area.…”

Estimates of the Open Economy New Keynesian Phillips Curve for Euro Area Countries

“…There is large evidence in the literature that the baseline New Keynesian Phillips Curve model with the labor share proxying real marginal cost as a driving variable of inflation can explain inflation dynamics in many large industrial economies reasonably well; see Gali and Gertler [6] and Sbordone [15] for the US, and Gali, Gertler and Lopez-Salido [7], McAdam and Willman [12] for the Euro Area and Balakrishnan and Lopez-Salido [1] for the UK.…”

“…However, a number of studies have also shown that the baseline model is not always appropriate in tracking inflation dynamics in particular for open economies, see Balakrishnan and Lopez-Salido [1] for the UK, Bardsen et al [2] for European countries, Freystätter [5] for Finland, and Sondergaard [17] for Germany, France and Spain. Reduced form estimates for the marginal cost term in the baseline model are often found to be insignificant in these studies.…”

Estimating the New Keynesian Phillips Curve for the UK: evidence from the inflation-indexed bonds market

“…Gulyàs and Startz (2006) uses break-even inflation rate as a measure of expected inflation and find similar results. 21 In fact, Balakrishnan and Lopez-Salido (2002) and Kara and Nelson (2003) find that the relationship between marginal cost and inflation disappears in the mid-1980s in case of the UK. 22 Notice that the evidence from the 4-year spot rate does support these findings.…”