The Effect of Globalization on Inflation in New Emerging Markets

Abstract

We investigate the effect of economic globalization on domestic inflation in twenty-one new emerging economies over the period 1990–2009. The empirical analysis using dynamic panel data models shows that the effect of domestic and global economic slacks on domestic inflation in the new emerging economies has changed significantly since the end of the 1990s. Before the end of the 1990s, the domestic economic slack played a predominant role in driving domestic inflation. After the year 2000, however, the global economic slack played a significant and more important role in affecting domestic inflation. This finding implies that the prescription that central banks should specifically react to developments in global output is justified for the new emerging economies over the most recent decade.

KEY WORDS:

• inflation
• inflation dynamics
• new emerging markets
• trade openness

Notes

^1. In particular, Ball (2006) criticizes the idea that a country’s inflation depends on output in its trading partners, not its own output. Ball believes that the augmented Phillips curve with foreign output gaps may not have a theoretical justification.

^2. There are twenty-one NEM countries in our analysis: nine in Asia (China, India, Indonesia, Israel, Korea, Malaysia, Philippines, Taiwan, and Thailand), six in Latin America (Argentina, Brazil, Chile, Colombia, Mexico, and Peru), and six in Europe and Africa (Czech Republic, Hungary, Poland, Russia, Turkey, and South Africa). Although the term NEM may be loosely defined, countries that fall into this category, varying from very big to very small, are usually considered to be newly emerging because of their developments and reforms. Countries belong to this category because they have embarked on economic development and reform programs and have begun to open up their markets and recently “emerge” onto the global economy.

^3. The data for inflation series in most countries are available from 1991Q4 to 2009Q3 (Q denotes quarter; data for China and Czech Republic start from 1992 and for Russia from 1993), while the data for real output gap spans 1993Q1–2009Q3, dictated by availability.

^4. There are several additional hypotheses for globalization and inflation nexus highlighting alternative channels through which globalization affects inflation, including global factor and product markets (Ihrig et al. 2010), global competition (Chen, Imbs, and Scott 2004; Sbordone 2009), and the terms of trade (Rogoff 2006).

^5. We thank the referee for reminding us about this point.

^6. There may be unobserved time-specific effects over the period considered in the article arising from, among many other possibilities, the change to inflation targeting and flexible exchange rate regimes implemented by many countries in the sample from the 1990s to early 2000. In practice, however, adding time-specific dummies (at quarterly frequency) consumes a substantial number of degrees of freedom, which consequently causes very unreliable estimates.

^7. Note that the regression sample pertaining to the results in Table 4 is the whole sample of 1993–2009, so it is unsurprising to observe that the domestic output gap is significant while the foreign output gap is insignificant. When we split the sample by 1999, the estimation results provide a scenario similar to that in Table 2.

Additional information

Funding

The research is supported by the National Natural Science Foundation of China (No. 71173224).