Publication - The globalisation of inflation: the growing importance of global value chains - by Raphael Auer, Claudio Borio and Andrew Filardo
At the heart of the globalisation of inflation (GI) hypothesis is the view that the factors influencing domestic inflation have become increasingly global. One implication of this hypothesis is that global, and not just domestic, measures of economic slack should be relevant determinants of domestic inflation and that their role should have increased with global economic integration (eg Borio and Filardo (2007)).
This more “globe-centric” view of the inflation process stands in contrast to traditional, “country-centric”, characterisations, in which a Phillips curve relates a purely domestic output gap to domestic inflation.
Because of its far-reaching implications for our understanding of inflation and the conduct of monetary policy, the GI hypothesis has attracted considerable attention. The hypothesis was hotly debated already before the Great Financial Crisis (GFC) of 2007–2009 (Bean (2006), Fisher (2006), Yellen (2006) and Bernanke (2007)), and has become even more prominent since (Caruana (2012), Carney (2015), Fischer (2015), Jordan (2015), Draghi (2016) and Poloz (2016)).2
While it is generally agreed that domestic inflation rates have been co-moving more closely (Ciccarelli and Mojon (2010)), the correct interpretation of this finding hinges on the validity of the GI hypothesis. Proponents argue that tighter comovements reflect, in particular, the growing structural integration of goods and labour markets. This would, for instance, propagate national cost shocks more widely and strongly. By contrast, sceptics place greater weight on common policies. The empirical evidence so far has not yielded conclusive results.3
In this paper, we attempt to extend the literature on globalisation and inflation by exploring the role that the growth of global value chains (GVCs) can play in explaining the increasingly global nature of domestic inflation. The growth of GVCs during the past several decades reflects the international integration of more geographically fragmented global production processes, made possible by new technologies and lower trade barriers. One would expect this expansion to lead to a generalised increase in international competitive pressures4 and to weaken the relevance of purely national resource constraints on the inflation process.
To assess this hypothesis, we evaluate the extent to which various proxies for GVCs explain the relative importance of global and domestic measures of slack in influencing domestic inflation. We do so in a panel setting, thereby exploring the relevance of GVCs both across countries and over time. To track the growth of GVCs, we consider total trade and its major components, focusing in particular on intermediate goods and services. To measure the influence of global and domestic slack on inflation, we rely on the published estimates of Bianchi and Civelli (2015) – estimates that are in the spirit of the analysis of Borio and Filardo (2007). That recent paper provides estimates that capture greater time variation (annual estimates for each country) and cover a wider range of countries than the earlier paper. We exclude the GFC period and its aftermath owing to the powerful balance sheet dynamics that appear to dominate the typical cyclical forces.
We find that GVCs are a key to explaining the influence of global factors on domestic inflation. There is statistically significant evidence that the growth of international input-output linkages explains the increasing sensitivity of domestic inflation to global factors. This is the case both across countries and over time. The growth of GVCs is associated with both a reduction of the impact of domestic slack on domestic inflation and an increase in that of its global counterpart.5 Moreover, once the role of GVCs is taken into account, we find that the conventional measure of trade openness so extensively used in the literature, based on the aggregate volume of trade in goods and services, has only limited explanatory power for the link between globalisation and domestic inflation.
The paper proceeds as follows. The first section briefly describes the evolution of international input-output linkages and explores their possible link with inflation. The second section outlines the methodology for constructing measures of GVCs and of global slack’s influence on domestic inflation. The third section examines the extent to which the growth of GVCs has influenced the relationship between global slack and domestic inflation, both across countries and over time. The conclusion raises some broader issues for policy and future research.
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