Inflation

BIS Working Papers
No 227

Globalisation and inflation: New cross-country evidence on the global determinants of domestic inflation
by Claudio Borio and Andrew Filardo

Monetary and Economic Department
May 2007

JEL Classification Numbers: E31, E52, E58, F02, F41 Keywords: Globalisation, Phillips curve, inflation, monetary policy

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Globalisation and inflation: New cross-country evidence on the global determinants ofdomestic inflation
by Claudio Borio and Andrew Filardo *

Abstract
There has been mounting evidence that the inflation process has been changing. Inflation is now much lower and much more stable around the globe. And its sensitivity to measures of economic slack and increases in input costs appears to have declined. Probably the most widely supported explanation for this phenomenon is thatmonetary policy has been much more effective. There is no doubt in our mind that this explanation goes a long way towards explaining the better inflation performance we have observed. In this paper, however, we begin to explore a complementary, rather than alternative, explanation. We argue that prevailing models of inflation are too “country-centric”, in the sense that they fail to takesufficient account of the role of global factors in influencing the inflation process. The relevance of a more “globe-centric” approach is likely to have increased as the process of integration of the world economy has gathered momentum, a process commonly referred to as “globalisation”. In a large cross-section of countries, we find some rather striking prima facie evidence that this has indeed beenthe case. In particular, proxies for global economic slack add considerable explanatory power to traditional benchmark inflation rate equations, even allowing for the influence of traditional indicators of external influences on domestic inflation, such as import and oil prices. Moreover, the role of such global factors has been growing over time, especially since the 1990s. And in a number ofcases, global factors appear to have supplanted the role of domestic measures of economic slack.

*

Email: Claudio.Borio@bis.org and Andrew.Filardo@bis.org.

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Contents
Introduction ...............................................................................................................................1 I. The conceptual framework: two perspectives on the inflationprocess..................................2 Inflation determination: the interaction of real and monetary factors...............................2 The country-centric approach..........................................................................................4 The globe-centric approach.............................................................................................4 Confronting theapproaches with the “real world” and globalisation................................5 II. Testing for the impact of global factors.................................................................................8 Related studies................................................................................................................8 Extended Phillips curve approach: the methodology...