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Domestic and global output gaps as inflation drivers: what does the Phillips curve tell?

Summary:
BIS Working Papers  |  No 748  |  28 September 2018 by  Martina Jašová, Richhild Moessner and Előd Takáts PDF full text (292kb)  |  31 pages Summary Focus It is critical to understand the changes globalisation brought to the inflation process after the financial crisis. To what degree do domestic versus global factors, such as output gaps, drive inflation? How has the role of these output gaps evolved since the financial crisis? And to what degree does the inflation process differ between advanced economies and less well studied emerging market economies? Contribution Our paper

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BIS Working Papers  |  No 748  | 
28 September 2018
PDF full text
 (292kb)
 |  31 pages

Summary

Focus

It is critical to understand the changes globalisation brought to the inflation process after the financial crisis. To what degree do domestic versus global factors, such as output gaps, drive inflation? How has the role of these output gaps evolved since the financial crisis? And to what degree does the inflation process differ between advanced economies and less well studied emerging market economies?

Contribution

Our paper investigates these questions in a framework - the New Keynesian Phillips curve framework - which allows the results to be interpreted for monetary policy. The investigation uncovers very different trends between advanced and emerging market economies. And, to the best of our knowledge, this is the first paper that explicitly addresses the issue of the strong co-movement across global and domestic output gaps when estimating their effects on inflation.

Findings

We find broadly that both domestic and global output gaps matter: both across regions (advanced and emerging market economies) and across time (before and after the financial crisis.) Furthermore, we find suggestive evidence for very different trends between advanced and emerging market economies after the global financial crisis: whereas in advanced economies the effect of the domestic output gap declines, in emerging market economies it is the effect of the global output gap that declines.

 

Abstract

We study how domestic and global output gaps affect CPI inflation. We use a New Keynesian Phillips curve framework, which controls for non-linear exchange rate movements for a panel of 26 advanced and 22 emerging economies covering the 1994Q1-2017Q4 period. We find broadly that both global and domestic output gaps are significant drivers of inflation both in the pre-crisis (1994-2008) and post-crisis (2008-2017) periods. Furthermore, after the crisis, in advanced economies the effect of the domestic output gap declines, while in emerging economies the effect of the global output gap declines. The paper demonstrates the usefulness of the New Keynesian Phillips curve in identifying the impact of global and domestic output gaps on inflation.

JEL classification: E31, E58, F62

Keywords: output gaps, global factors, inflation

International Settlement
The Bank for International Settlements (BIS) is an international company limited by shares owned by central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks". The BIS carries out its work through subcommittees, the secretariats it hosts and through an annual general meeting of all member banks. It also provides banking services, but only to central banks and other international organizations. It is based in Basel, Switzerland, with representative offices in Hong Kong and Mexico City.

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