How can globalization affect inflation? Example of EMU countries

Abstract

Globalization is a phenomenon researchers have paid great attention to in recent years. They estimated that globalization is a key structural dynamic that could keep inflation low, especially in developed economies. Therefore, the aim of the paper is to examine the impact of globalization, i.e. its dimensions (economic, social, and political), on inflation in EMU countries as developed economies. Researchers use data from 1970 to 2021. ARDL approach is used to test the short and long-run relationship between globalization and inflation. The results show an increasing effect of globalization on inflation in the short-run and a decreasing effect in the long-run. The short-run effect of economic globalization results from the harmonisation process, while the long-run effect results from stronger competition with more domestic and abroad enterprises. The conclusions could give good recommendations to the policymakers on explaining the effect of economic globalization (trade, FDI flows, portfolio investment, etc.) on inflation and which long-run benefits economic globalization and openness have on inflation.

JEL classification:

• F62
• E31
• F41
• C22

Keywords:

• Globalization
• inflation
• EMU countries
• economic
• social and political globalization

Reviewing Editor:

• Robert Read, Economics, University of Lancaster, Lancaster, UK

Subjects:

• Economics and Development
• Macroeconomics
• Development Economics

1. Introduction

Globalization is a phenomenon to which researchers have paid great attention in recent years. Still, a consensus has not yet been reached, and a unique definition of this term has not been given. The term globalization is most often used to indicate changes in society, economy and other areas that contribute to increasing international trade and transactions. Globalization results in an increasingly interdependent world, implying growing economic interdependence and social and political interaction between companies and individuals worldwide (World Commission on the Social Dimension of Globalization, 2005). In the broadest sense, globalization refers to expanding global ties and representing a multidimensional process that includes economic, political, cultural, and other components. Therefore, different authors define globalization differently. According to the International Monetary Fund (IMF), globalization represents a growing interdependence of all countries, created by the increase and diversification of the number of international transactions and accelerated and generalized technological exchange. Waters (1995) defines globalization as a social process in which geographical constraints on social and cultural events disappear, and people become increasingly aware of it. Kellner (1998) considers globalization to be a multidimensional phenomenon involving a wide range of diverse flows of products, services, capital, people, information, ideas and technologies. Also, a set of economic, political, cultural, and ideological forces shaping the trajectory of global change that overlapping and interconnect on local, national, regional, and international levels. Mullins and Murphy (2009) characterize globalization as cross-border flows of money, trade, communications, values, and ideologies.

Globalization has a wide impact on every part of human life and activities. The effects could be very significant, especially in business and economic activities. In that sense, globalization could affect the inflation rate, as one of the important economic indicators, especially in much more opened and developed economies. Some research has shown that the expansion of Global Value Chains increases direct and indirect competition between economies, making domestic inflation more sensitive to the global output gap and affecting central banks’ choices in managing inflation (Burgess, 2017). Deardorff and Stern (2001) state that globalization lays a healthy foundation for economic growth by reducing inflation and accelerating technological progress and productivity growth. Guirguis et al. (2022) argue in the example of the US economy that global inflation has a strong impact on domestic inflation. About 80% of domestic inflation in the US is imported from the global inflation rate, which means that global related to the prices influence domestic prices. Accordingly, the aim of this research is to examine the impact of globalization, i.e., its dimensions (political, social, and economic), on inflation in EMU countries. This impact is very important for policymakers because the effects of monetary policy are strongly affected by globalization especially in much more opened economies, such as EMU countries (Kohn, 2006; Lodge et al., 2021; Rogoff, 2007). That is why policy makers and scientists have to know more about this phenomenon and how it can affect their decisions. The main contribution of the paper is estimating of the influence of globalization on inflation in very long period, from 1970 to 2021. The results can help policy makers, especially monetary regulators, to adapt their policies to this influence. There is not much this type of research, especially, studies that use the KOF index as a proxy of globalization. Also, there is a lack of researches about the impact of globalization and all its dimensions (economic, social and political) on the inflation in EMU countries and this research will fill this gap. Also, in many researches there are different researches results about impact of globalization on inflation, and the research try to solve this diversity of results using more reliable methodology for estimating influence of globalization on inflation.

In line with the research aim, the paper is structured as follows. A literature review on the impact of globalization on inflation is presented in Section One. An overview of the methodology is shown in Section Two. The empirical research findings are presented and discussed in Section Three. At the end of the paper are concluding remarks with recommendations for policymakers.

2. Literature review

Globalization connects all the countries involved through trade, transfer of technology, foreign direct investment, and the interchange of people and physical capital, which can result in economic growth (Zaidi et al., 2019). Measure which can be used for estimation level of globalization in each country is KOF index introduced by Dreher (2006) modified and revisited by authors such as Martens et al. (2015) and Gygli et al. (2019). Basically KOF index has three dimensions which estimated level of globalization: economic, social and political dimensions. Still, there is not much research about the impact of globalization and its dimensions on inflation, especially studies that use the KOF index. Furthermore, there is no consensus about the effects of globalization on inflation. The existing research shows different views on the impact of globalization on inflation, ranging from a decreasing effect (Badinger, 2009; Chang & Tsai, 2015; Degtev et al., 2022; Pehnelt, 2007; Rogoff, 2003; Samimi et al., 2012), to increasing effects (Taiebnia & Zandiyeh, 2009; Zhang et al., 2015) and non-significant effects (Ball, 2006; Guilloux & Kharroubi, 2008).

Studies by Rogoff (2003), Pehnelt (2007), Badinger (2009), Samimi et al. (2012), Chang and Tsai (2015) and Degtev et al. (2022) found that globalization decreases inflation. According to Rogoff (2003), globalization decreases inflation. Pehnelt (2007) also researched the effect of globalization on inflation using the KOF index as a proxy for globalization in 22 OECD countries. The results showed that the KOF index of globalization has a decreasing, statistically significant, effect on inflation, which means that globalisation decreases inflation. Badinger (2009) also found the decreasing effect of globalization on inflation in 91 countries from 1985 to 2004. Samimi et al. (2012) also investigated the impact of globalization on inflation using the KOF index as a proxy of globalization in Iran from 1970 to 2009. They used the ARDL Bounds test approach to analyze the relationship between these variables, and the results showed that there is a decreasing effect of globalisation on inflation in the long-run. Furthermore, the results showed that there is a statistically significant decreasing short-run effect of globalization on inflation. Degtev et al. (2022), argue on a sample of 16 countries, eight advanced economies (Germany, Canada, France, Japan, the Republic of Korea, the USA, the UK, and Singapore) and the eight largest economies among emerging market countries (Brazil, China, India, Mexico, the Russian Federation, Nigeria, Saudi Arabia, and South Africa) that inflation rate and globalization factors have a negative correlation, i.e. a high degree of globalization leads to a decrease of inflation risks. Chang and Tsai (2015) examined the relationship between globalization and inflation in OECD countries from 1970 to 2010 and found a decreasing effect of globalization on inflation. Furthermore, the authors found a bidirectional relationship between globalization and inflation in Italy.

Some studies found that globalization increases inflation (Taiebnia & Zandiyeh, 2009; Zhang et al., 2015). Taiebnia and Zandiyeh (2009) investigated the impact of globalization on inflation using the VAR model in Iran from 1988 to 2005. They found that import-relative price increases act as a supply shock in the economy and increase inflation. Zhang et al. (2015) investigated the relationship between economic globalization and inflation in China using quarterly data from 1995 to 2012. They found a significant relationship between the global output gap and inflation in China. Zhang (2015) also examined the effect of globalization on inflation in new emerging markets from 1990 to 2009 using dynamics panel data models. The author found that prior to the end of the 1990s, domestic economic slack was the primary driver of domestic inflation, while after 2000, global economic slack became the primary driver of domestic inflation.

Ball (2006) and Guilloux and Kharroubi (2008) showed that globalization does not have a significant impact on inflation. Ball (2006) investigated the impact of globalization on inflation in 14 countries from 1985 to 2005 by estimating the Phillips curve using the Ordinary Least Square method (OLS). The results showed that there is no significant impact of globalization on inflation. Guilloux and Kharroubi (2008) analyzed the impact of globalization on inflation in OECD countries from 1980 to 2005 using the GMM method (Generalized Methods of Moments). The results showed no significant effect of trade volume as a proxy of globalization on inflation.

Studies by Calza (2009) and Mazumder (2017) found that globalization has little impact on inflation. Calza (2009) analyses the relationship between globalization, domestic inflation and global output gaps in the Euro area using quarterly data from 1979 to 2003. The author found that globalization has minimal explanatory value for domestic inflation in the euro area. Mazumder (2017) investigated the relationship between globalization and inflation in 189 developing and emerging economies from 1969 to 2009 and found that globalization has had little impact on inflation in developing economies. This means that in some periods there is no influence of globalisation on inflation, or this influence is low.

Also, some authors estimated the effects of global factors, especially foreign shocks on domestic inflation trends and inflation gaps. The conclusion is that inflation trends in emerging market economies are more affected by foreign shocks in contrast to developed economies (Kamber & Wong, 2020). This means that emerging market economies are more sensitive to the globalization process and external shocks.

According to mentioned researches, the hypothesis tested in this research is that globalisation has a statistically significant, decreasing effect on inflation in EMU countries in the short and long-run. This means that greater involvement of the EMU countries in global flows decreases the inflation rate in these countries. Furthermore, the three dimensions of the KOF index – political, economic, and social dimension will be used as proxies for globalization, which differs this paper from previous research. The estimated impact of globalization on inflation through three dimensions of globalisation is specific to the research. The research is focused especially on economic globalization which is more important for policymakers than the other two. This approach can help policymakers to prepare better policy (especially monetary policy) for inflation targeting in the short and long-run.

3. Data and methodology

3.1. Data

Annual data for inflation, GDP growth rate and globalization from 1970 to 2021 for the following EMU countries Austria, Belgium, Cyprus, Germany, Spain, Finland, France, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, and Portugal were used. Data for inflation were retrieved from World Bank databases, while the data for economic, social, and political globalization were retrieved from ETH – Swiss Economic Institute. The European Central Bank targets inflation at 2% in the euro area. Market barriers are removed due to globalization, which also promotes competitive commerce and stabilizes market pricing (Liu et al., 2022). EMU countries are also the EU countries that, as a single market, have free movement of capital, people, goods and services. Therefore, we used the sample of EMU countries to investigate the relationship between globalization and inflation. Data and sources of data are presented in Table 1.

Table 1. Sources of data.

Variable	Measure	Source
CPI	Inflation (%)	World Bank
EMU	EMU membership	European Commission
GDPG	GDP growth rate (%)	World Bank
KOFE	The economic dimension of globalization	ETH - Swiss Economic Institute
KOFS	The social dimension of globalization	ETH - Swiss Economic Institute
KOFP	The political dimension of globalization	ETH - Swiss Economic Institute

CPI – Consumer Price Index – is a proxy of inflation and shows an increase in the general price level. It reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals (World Bank, 2020; Diallo, 2016). It is the dependent variable.

KOFP – The Political Dimension of Globalization is characterized by a diffusion of government policies (ETH Swiss Economic Institute, 2019). It includes embassies in the country, membership in international organizations, and participation in the UN Security Council Mission (Pekarskiene & Susniene, 2011).

KOFE – The Economic Dimension of Globalization is characterized by goods, capital, and services flows and the information and perception accompanying the market exchange (ETH Swiss Economic Institute, 2019). It includes actual flows (trade, FDI flows, FDI stocks, portfolio investment, income paid to foreign nationals) and restrictions (hidden import barriers, mean tariff rate, taxes on international trade, and capital account restrictions) (Pekarskiene & Susniene, 2011).

KOFS – The Social Dimension of Globalization is expressed as disseminating ideas, information, images, and people (ETH Swiss Economic Institute, 2019). It includes data on personal contact (telephone traffic, transfers, international tourism, foreign population, and international letters), data on information flows (internet users, television, trade-in newspapers, radio), and data on cultural proximity (number of McDonald’s restaurants, number of Ikea stores, and trade-in books) (Pekarskiene & Susniene, 2011).

A detailed description of globalization’s political, economic, and social dimensions and its weights is in Appendix Table A1. KOFP, KOFE, and KOFS are independent variables.

GDPG – Gross Domestic Product growth rate (GDP growth rate) is an annual percentage growth rate of GDP at market prices (World Bank, 2020).

EMU – EMU Membership is the dummy variable that takes value if the country is a member of the European Monetary Union in period t, 0 otherwise. The detailed list of observed countries and the year they became EMU members is given in Appendix Table A2. GDPG and EMU are control variables in the research.

Table 2. Descriptive statistics.

Variable	Mean	Standard Deviation	Minimum	Maximum	Number of observations
Inflation	4.78	5.24	−4.48	31.02	728
Political globalization (KOFP)	81.19	16.01	31.78	98.71	728
Economic globalization (KOFE)	69.67	14.93	29.70	93.47	728
Social globalization (KOFS)	75.96	9.12	51.82	92.11	728
GDP growth	2.88	3.54	−11.33	25.16	728

Source: Author’s calculations in EViews 10.

3.2. Methodology

Based on previous empirical research done by Pehnelt (2007) and Samimi et al. (2012), with some modifications, a model was developed to estimate the effect of globalization on inflation in EMU countries. The empirical research by Pehnelt (2007) and Samimi et al. (2012) included overall globalization index (KOF), while this research developed model with three dimensions of globalization: political, economic, and social. The following equations set the models: (1) $$\mathit{\text{CP}}{I}_{\mathit{\text{it}}}=f\left(\mathit{\text{KOF}}{P}_{\mathit{\text{it}}},\mathit{\text{KOF}}{E}_{\mathit{\text{it}}},\hspace{0.17em}\mathit{\text{KOF}}{S}_{\mathit{\text{it}}},\hspace{0.17em}\mathit{\text{GDP}}{G}_{\mathit{\text{it}}}\right)$$(1) (2) $$\mathit{\text{CP}}{I}_{\mathit{\text{it}}}=f\left(\mathit{\text{KOF}}{P}_{\mathit{\text{it}}},\mathit{\text{KOF}}{E}_{\mathit{\text{it}}},\mathit{\text{KOF}}{S}_{\mathit{\text{it}}},\mathit{\text{GDP}}{G}_{\mathit{\text{it}}},\mathit{\text{EM}}{U}_{\mathit{\text{it}}}\right)$$(2) where CPI_it is the consumer price index in i EMU country in t period (a proxy for inflation), KOFPit is the political dimension of the KOF Globalization Index in i EMU country in t period, KOFEit is the economic dimension of the KOF Globalization Index in i EMU country in t period and KOFSit is the social dimension of the KOF Globalization Index in i EMU country in t period, GDPGit is the GDP growth rate in i EMU country in t period, EMUit is EMU membership (1 if the country is the member of European monetary union in period t, 0 otherwise), t = 1970, …, 2021.

Cross-section dependence and unit root tests were applied to determine whether there is a correlation and whether the data are integrated of the same order. Auto Regressive Distributed Lag (ARDL) approach was used to examine the long-run and short-run relationship between globalization (all three dimensions) and inflation, which according to Ghatak and Siddiki (2001), produces statistically significant results on relatively small samples. Therefore, the following equations will be estimated. Models differ by including control variables. The control variable in the first model (Model 1) is the GDP growth rate, while in the second (Model 2), the control variables are the GDP growth rate and EMU Membership.

Model 1: (3) $$\begin{array}{c}{\mathit{\text{DCPI}}}_{\mathit{\text{it}}}={\gamma }_1{\mathit{\text{ECT}}}_{i,t-j}+{\displaystyle \sum }_{j=1}^k{\beta }_{j2}{\mathit{\text{DCPI}}}_{i,t-j}+{\displaystyle \sum }_{j=0}^k{\delta }_{j2}{\mathit{\text{DKOFP}}}_{i,t-j}+{\displaystyle \sum }_{j=0}^k{\theta }_{j2}{\mathit{\text{DKOFE}}}_{i,t-j}+{\displaystyle \sum }_{j=0}^k{\rho }_{j2}{\mathit{\text{DKOFS}}}_{i,t-j}\\ +{\displaystyle \sum }_{j=0}^k{\nu }_{j2}{\mathit{\text{DGDPG}}}_{i,t-j}+\alpha +\mathit{\text{trend}}+{\epsilon }_{\mathit{\text{it}}}\end{array}$$(3) where β_j2, δ_j2, θ_j2, ρ_j2, ν_j2 are coefficients, εit is the white noise term, γ2 is the coefficient of the ECT (error-correction term). The coefficient γ₁ explains the long-term relationship between the variables presented in equation (4)(4) $$\mathit{\text{EC}}{T}_{i,t-j}=\mathit{\text{CP}}{I}_{\mathit{\text{it}}}-\hspace{0.17em}\alpha -\hspace{0.17em}{\displaystyle \sum }_{j=1}^k{\beta }_{j3}\mathit{\text{CP}}{I}_{i,t-j}-{\displaystyle \sum }_{j=0}^k{\delta }_{j3}\mathit{\text{DKOF}}{P}_{i,t-j}-{\displaystyle \sum }_{j=0}^k{\theta }_{j3}\mathit{\text{KOF}}{E}_{i,t-j}-\hspace{0.17em}{\displaystyle \sum }_{j=0}^k{\rho }_{j3}\mathit{\text{DKOF}}{S}_{i,t-j}-\hspace{0.17em}{\displaystyle \sum }_{j=0}^k{\nu }_{j3}\mathit{\text{DGDP}}{G}_{i,t-j}$$(4) . (4) $$\mathit{\text{EC}}{T}_{i,t-j}=\mathit{\text{CP}}{I}_{\mathit{\text{it}}}-\hspace{0.17em}\alpha -\hspace{0.17em}{\displaystyle \sum }_{j=1}^k{\beta }_{j3}\mathit{\text{CP}}{I}_{i,t-j}-{\displaystyle \sum }_{j=0}^k{\delta }_{j3}\mathit{\text{DKOF}}{P}_{i,t-j}-{\displaystyle \sum }_{j=0}^k{\theta }_{j3}\mathit{\text{KOF}}{E}_{i,t-j}-\hspace{0.17em}{\displaystyle \sum }_{j=0}^k{\rho }_{j3}\mathit{\text{DKOF}}{S}_{i,t-j}-\hspace{0.17em}{\displaystyle \sum }_{j=0}^k{\nu }_{j3}\mathit{\text{DGDP}}{G}_{i,t-j}$$(4) where β_j3, δ_j3, θ_j3, ρ_j3, ${\nu }_{j3}$ are coefficients.

Model 2: (5) $$\begin{array}{c}{\mathit{\text{DCPI}}}_{\mathit{\text{it}}}={\gamma }_4{\mathit{\text{ECT}}}_{i,t-j}+{\displaystyle \sum }_{j=1}^k{\beta }_{j6}{\mathit{\text{DCPI}}}_{i,t-j}+{\displaystyle \sum }_{j=0}^k{\delta }_{j6}{\mathit{\text{DKOFP}}}_{i,t-j}+{\displaystyle \sum }_{j=0}^k{\theta }_{j6}{\mathit{\text{DKOFE}}}_{i,t-j}+{\displaystyle \sum }_{j=0}^k{\rho }_{j6}{\mathit{\text{DKOFS}}}_{i,t-j}+{\displaystyle \sum }_{j=0}^k{\nu }_{j6}{\mathit{\text{DGDPG}}}_{i,t-j}\\ +{\displaystyle \sum }_{j=0}^k{\lambda }_{j6}{\mathit{\text{EMU}}}_{i,t-j}+\alpha +\mathit{\text{trend}}+{\epsilon }_{\mathit{\text{it}}}\end{array}$$(5) where β_j6^{, δ}_j6^{, θ}_j6^{, ρ}_j6, ν_j6, λ_j6 are coefficients, εit is the white noise term, γ4 is the coefficient of the ECT (error-correction term). The coefficient γ₄ explains the long-term relationship between the variables presented in equation (6)(6) $$\mathit{\text{EC}}{T}_{i,t-j}=\mathit{\text{CP}}{I}_{\mathit{\text{it}}}-\hspace{0.17em}\alpha -\hspace{0.17em}{\displaystyle \sum }_{j=1}^k{\beta }_{j5}\mathit{\text{CP}}{I}_{i,t-j}-{\displaystyle \sum }_{j=0}^k{\delta }_{j5}\mathit{\text{DKOF}}{P}_{i,t-j}-{\displaystyle \sum }_{j=0}^k{\theta }_{j5}\mathit{\text{DKOF}}{E}_{i,t-j}-\hspace{0.17em}{\displaystyle \sum }_{j=0}^k{\rho }_{j5}\mathit{\text{DKOF}}{S}_{i,t-j}-{\displaystyle \sum }_{j=0}^k{\nu }_{j5}\mathit{\text{DGDP}}{G}_{i,t-j}-\hspace{0.17em}{\displaystyle \sum }_{j=0}^k{\lambda }_{j5}\mathit{\text{DEM}}{U}_{i,t-j}$$(6) . (6) $$\mathit{\text{EC}}{T}_{i,t-j}=\mathit{\text{CP}}{I}_{\mathit{\text{it}}}-\hspace{0.17em}\alpha -\hspace{0.17em}{\displaystyle \sum }_{j=1}^k{\beta }_{j5}\mathit{\text{CP}}{I}_{i,t-j}-{\displaystyle \sum }_{j=0}^k{\delta }_{j5}\mathit{\text{DKOF}}{P}_{i,t-j}-{\displaystyle \sum }_{j=0}^k{\theta }_{j5}\mathit{\text{DKOF}}{E}_{i,t-j}-\hspace{0.17em}{\displaystyle \sum }_{j=0}^k{\rho }_{j5}\mathit{\text{DKOF}}{S}_{i,t-j}-{\displaystyle \sum }_{j=0}^k{\nu }_{j5}\mathit{\text{DGDP}}{G}_{i,t-j}-\hspace{0.17em}{\displaystyle \sum }_{j=0}^k{\lambda }_{j5}\mathit{\text{DEM}}{U}_{i,t-j}$$(6) where β_j5, δ_j5, θ_j5, ρ_j5, ${\nu }_{j5},{\lambda }_{j5}$ are coefficients.

The following section presents the results and interpretation of the aforementioned statistical tests to explore the relationship between globalization and inflation.

4. Results and discussion

4.1. Descriptive statistics

Table 2 shows descriptive statistics for all variables used in the research. The average inflation in EMU countries from 1970 to 2021 is 4.78 percent. Figure A1 in the Appendix shows the inflation in each country of EMU from 1970 to 2021. Inflation decreases in all countries in the observed period. The minimum inflation is -4.48 percent (Ireland, 2009), and the maximum inflation is 31.02 percent (Portugal, 1977). The world financial crisis may have caused the minimum inflation in Ireland in 2009. Deflation of similar magnitude had not been experienced in Ireland since the thirties, immediately following the Great Depression. Relative to other European countries, including those on programs of international financial assistance, the deflation experienced in Ireland was greater in magnitude and longer in duration (Bermingham et al., 2012).

The average political globalization in EMU countries from 1970 to 2021 is 81.19. The minimum political globalization is 31.78 (Malta, 1972), and the maximum is 98.71 (France, 2009). The average economic globalization in EMU countries from 1970 to 2021 is 69.67. The minimum economic globalization is 29.70 (Greece, 1970), and the maximum is 93.47 (Luxembourg, 2004). The average social globalization in EMU countries from 1970 to 2021 is 75.96. The minimum social globalization is 51.82 (Portugal, 1970), and the maximum is 92.11 (Luxembourg, 2016). Luxembourg has the highest average social and economic globalization. EMU countries’ average GDP growth rate from 1970 to 2021 is 2.88 percent. The minimum GDP growth rate is -11.33 percent, in Portugal in 2020, and the maximum is 25.16 percent, in Ireland in 2015 (Table 2). Figure A2 in the Appendix shows the GDP growth rate in EMU for individual countries from 1970 to 2021.

4.2. Cross-section dependence test results

A cross-section dependence test (Pesaran CD test) is used to analyze the null hypothesis that there is no cross-section dependence (correlation) in the time series (Pesaran, 2004). It is important to test for the cross-sectional dependence in a panel analysis because ignorance of the cross-section dependency leads to substantial bias in estimations. The results of the cross-section dependence test (Pesaran CD test) show that changes in inflation, the economic, social, and political dimensions of globalization, and GDP growth rate that occurred in any of the observed EMU countries affect other countries as well (there is a cross-section dependence in time series) (Table 3).

Table 3. Cross-section dependence test.

Variable	t-statistic
Inflation (CPI)	53.46***
Political globalization (KOFP)	59.72***
Economic globalization (KOFE)	63.22***
Social globalization (KOFS)	66.69***
GDP growth (GDPG)	37.12***

***indicates rejection of the null hypothesis at a 1% level of significance.

Source: Author’s calculations in EViews 10.

Since there is cross-section dependence in all-time series, the second generation of the unit root test (CIPS cross-section Im, Pesaran, and Shin) is used to determine the order of integration of variables and to get unbiased estimations (Pesaran, 2007).

4.3. Unit root test results

Table 4 shows Im, Pesaran, and Shin unit root test results (CIPS). The panel unit root test results show that the series is not integrated in the same order. Some series are stationary at level I(0), while other series are stationary at the first difference I(1).

Table 4. Im, Pesaran, and Shin unit root test results (CIPS).

Im, Pesaran, and Shin
Variable	Individual intercept	Individual intercept and trend	Decision
CPI	−3.63***	−3.78***	I(0)
KOFP	−2.16*	−2.39	I(1)
D(KOFP)	−6.19***	−6.42***
KOFE	−2.01	−2.12	I(1)
D(KOFE)	−6.03***	−6.26***
KOFS	−2.69***	−2.84***	I(0)
GDPG	−4.75***	−4.91***	I(0)

***indicates rejection of the null hypothesis at a 1% level of significance.

**indicate rejection of the null hypothesis at a 5% level of significance.

Source: Author’s calculations in Stata.

CPI, KOFS and GDPG are stationary at level I(0), while KOFE and KOFP are stationary at the first difference, I(1). The results of the panel unit root test are shown in Table 4. Therefore, the Panel ARDL test is used to test the relationship between inflation (CPI) and globalization (KOFP, KOFE, KOFS).

4.4. Panel ARDL test results

The results of the panel ARDL test for the relationship between globalization (political, economic, and social) and inflation for models represented by equations (3) – (6) are shown in Table 5 and Table 6. Table 5 shows the panel ARDL long-run results.

Table 5. Panel ARDL long-run results.

Dependent variable: CPI
Independent	Model	Model
Variable	(1)	(2)
KOFP	−0.15	−0.05
	(0.12)	(0.09)
	[-1.21]	[-0.49]
KOFE	−0.41***	−0.45***
	(0.10)	(0.08)
	[-3.88]	[-5.32]
KOFS	0.56***	−0.21
	(0.22)	(0.19)
	[2.64]	[-1.09]
GDPG	1.26***	0.89***
	(0.27)	(0.18)
	[4.74]	[4.98]
EMU		7.21***
		(1.13)
		[6.36]

Standard errors in () and t-statistics in [].

***statistically significant at a 1% level of significance.

**statistically significant at a 5% level of significance.

***statistically significant at a 10% level of significance.

Source: Author’s calculations in EViews 10.

Table 6. Panel ARDL short-run results.

Dependent variable: CPI
Independent	Model	Model
Variable	(1)	(2)
ECT	−0.20***	−0.25***
	(0.02)	(0.02)
	[-12.00]	[-13.74]
D(KOFP)	0.03	0.03
	(0.03)	(0.03)
	[0.86]	[1.06]
D(KOFE)	0.17***	0.23***
	(0.04)	(0.05)
	[4.48]	[4.96]
D(KOFS)	−0.13	−0.01
	(0.14)	(0.17)
	[-0.91]	[-0.09]
D(GDPG)	−0.14***	−0.13***
	(0.03)	(0.03)
	[-4.19]	[-3.96]
D(EMU)		−0.99***
		(0.57)
		[-1.74]
C	0.11***	11.90***
	(0.47)	(1.03)
	[0.23]	[11.61]
Trend	−0.01*	−0.01*
	(0.01)	(0.01)
	[-1.60]	[-1.50]

Standard errors in () and t-statistics in [].

***statistically significant at a 1% level of significance.

**statistically significant at a 5% level of significance.

*statistically significant at a 10% level of significance.

Source: Author’s calculations in EViews 10.

Model (1), besides independent variables (political, economic, and social dimensions of globalization), includes GDP growth rate as a control variable. The panel ARDL test results show that there is a decreasing and statistically significant effect of economic globalization on inflation at a 1% significance level in the long-run. Model (2), besides independent variables (political, economic, and social dimensions of globalization), includes GDP growth rate and EMU membership as control variables. The panel ARDL test results show that there is a decreasing and statistically significant effect of economic globalization on inflation at a 1% significance level (Model 2) in the long-run. The estimated effect of economic globalization on inflation in Model 2 (which includes GDP growth and EMU membership as control variables) is stronger than in the case of Model 1.

The results also reveal an increasing effect of social globalization on inflation in long-run, which is statistically significant, when controlling for GDP growth rate (Model 1), while this relationship is non-significant when controlling for EMU membership, besides GDP growth rate as a control variable (Model 2). The research results show that there is no statistically significant relationship between political globalization and inflation in both models in the long-run. While the GDP growth rate has an increasing effect on inflation which is statistically significant, in both models in the long-run. EMU membership also has an increasing effect on inflation which is statistically significant at a 1% significance level in the long-run (Table 5).

Since there is a decreasing effect of economic globalization on inflation in all models, it may be concluded that economic globalization decreases inflation in the long-run. The results are in line with those obtained by Rogoff (2003), Badinger (2009), Pehnelt (2007), and Samimi et al. (2012), who also found that globalization decreases inflation. Moreover, Samimi et al. (2012) conclude this for the long-run period.

The error correction term (ECT) for all models is negative and statistically significant and shows how much of the disequilibrium caused by a shock in the short-run will be corrected in the long-run. The speed of convergence to long-run equilibrium is crucial for the implementation of a common monetary policy. Policymakers should consider these dynamics when formulating and adjusting monetary policies. The error correction term (ECT) for model 1 with controlling variable GDP growth rate is -0.20 and statistically significant at 1%. In response to a shock, the speed of adjustment towards equilibrium is 20% annually. The error correction term (ECT) for model 2 with controlling variables GDP growth rate and EMU membership is -0.25 and statistically significant at a 1% level. It shows that in response to a shock, the speed of adjustment towards equilibrium is 25% annually (Table 6).

If short-run coefficients are observed, it may be concluded that there is an increasing effect of economic globalization on inflation which is statistically significant in both models (Table 6). The results for the short-run relationship are opposed to the results obtained for a long-run relationship but are in line with the results obtained by Taiebnia and Zandiyeh (2009), who also found the increasing effect of globalization on inflation. Furthermore, the GDP growth rate has a decreasing effect on inflation which is statistically significant (Models 1 and 2). The results are opposed to the long-run relationship results. Mamo (2012) used the Granger causality test causality from economic growth to inflation in the Congo Democratic Republic and Zimbabwe. Sattarov (2011) found a statistically non-significant effect of GDP on inflation in Finland.

In the short-run, there is a statistically significant decreasing effect of EMU membership on inflation. The results are opposed to the long-run relationship results (Table 6). Other variables (political and social globalization) do not statistically significantly affect inflation in the short-run (Table 6).

The robustness of data analysis was done by applying the panel ARDL approach to the sample of countries joined the EMU in 1999 (Austria, Belgium, Germany, Spain, Finland, France, Ireland, Italy, Luxembourg, Netherlands, and Portugal). Furthermore, a panel dynamic least squares (DOLS) method was conducted as a robustness test to ensure the strength of the estimates for both models. The results of the panel ARDL approach to the sample of countries joined the EMU in 1999 (Appendix Tables A3 and A4) and a panel dynamic least squares (DOLS) method (Table 5) showed that coefficients are slightly different, but their significance and sign have not been changed. Since the results are consistent across all analyses, it suggests that the analysis is robust to changes in the dataset, and that results are strong and reliable.

5. Conclusion

The relationship between globalization and inflation in EMU countries is examined using the ARDL approach. The ARDL test results show a decreasing effect of economic globalization on inflation in the long-run, while there is an increasing effect of economic globalization on inflation in the short-run. In the short-run, an increase in economic globalisation level increases EMU countries’ inflation rate. In the long-run, an increase in economic globalization decreases the inflation rate in EMU countries. Therefore, the hypothesis that globalization, especially its economic dimension, has a decreasing effect on inflation in the short and long-run is partially confirmed.

Based on these findings, one can conclude that economic openness driven by economic globalization could increase prices in the short-run. The process of price harmonization among countries, as a result of globalization, can be one of the reasons for prices increasing in the short-run. Also, there is the process of market liberalization, which can push up prices. When these two processes are finished, countries can expect price reductions due to higher competition with more domestic and abroad enterprises. The price-decreasing process is longer than the price-increasing process. Post COVID-19 crisis with inflation proves this conclusion. Globalization could be an engine of price increases among countries in the short-run. Because of the high globalization, especially in the case of EMU countries, inflation is overflowing among countries easily. After the short-run effect of global inflation on price increases among countries, one could expect long-run price stabilization and decrease.

Romer (1993) explained the decreasing effect of openness on inflation, in more open economies, with more responsible monetary policy. Every unanticipated monetary expansion causes real exchange rate depreciation as an engine of inflation. The harms of real depreciation are greater in more open economies and the benefits of expansion decrease with openness. This is why monetary authorities in these economies have to be more responsible. Thus, monetary authorities in more open economies are less likely to conduct monetary expansion. As a result, the average inflation rate is lower in more open economies (Granato et al., 2007; Lin et al., 2017). That is the case with EMU economies. These conclusions could give good recommendations to the policymakers on explaining the effect of economic globalization (trade, FDI flows, portfolio investment, tax on international trade, etc.) on inflation and which long-run benefits economic globalization and openness have on inflation. The research highlights understanding the short-run and long-run effects of globalization on inflation because it allows better policy interventions. For example, during periods of economic harmonization, policymakers might need to consider inflationary pressures, while in the long-run, they can leverage the benefits of increased competition to mitigate inflation.

This is one of the few researches related to developed countries and members of EMU and it can fill knowledge in this research area. The paper provides insights into the dynamics of globalization’s effect on inflation, highlighting the contrasting short-run and long-run effects. By distinguishing short-term and long-term effects, the study offers insights into how the impact of globalization on inflation may vary over time. The identification of an increasing effect of economic globalization on inflation in the short-run adds depth to the understanding of inflationary pressures. This insight suggests that, immediately after increased economic globalization, developed countries (such as EMU countries) might experience a rise in their inflation rates. The decreasing effect of economic globalization on inflation, in the long-run, contributes to discussions about the potential stabilizing influence of globalization over time. This finding implies that, in the extended period, economic globalization may contribute to a decrease in inflation rates. Also, focusing specifically on EMU countries adds a contextual dimension to the analysis.

The findings can stimulate further research into the underlying mechanisms driving these effects, enabling a more comprehensive understanding of the relationship between economic globalization and inflation. Besides that, future research could be improved. Future research should include a broader sample of countries over an extended period. The author also recommends including more variables in the study to capture the effects of real interest rates, money supply, etc.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Additional information

Notes on contributors

Milan Kostić

Milan Kostić, PhD, is full professor at University of Kragujevac, Faculty of Economics. Research interests of Milan Kostić are microeconomics, industrial organization, economic analyses in competition policy, globalization and inflation.

Marija Radulović

Marija Radulović, PhD, is Research Associate at University of Kragujevac, Faculty of Economics, Serbia. Her research is related to national competitiveness, competition policy, globalization, foreign direct investment, and inflation.

Appendix

Figure A1. Consumer Price Index by EMU country, 1970-2021.

Source: Author in EViews 10.

Figure A2. GDP growth rate by EMU country, 1970-2021.

Source: Author in EViews 10.

Table A1. KOF globalization index and its dimensions.

Indices and variables	Weights
Economic globalization	37%
1.1. Actual Flows	50%
Trade (% of GDP)	18%
FDI flows (% of GDP)	21%
FDI stocks (% of GDP)	22%
Portfolio Investment (% of GDP)	19%
Income paid to foreign nationals (% of GDP)	20%
1.2. Restrictions	50%
Hidden import barriers	24%
Mean tariff rate	28%
Taxes on International trade (% of current revenue)	27%
Capital account restrictions	20%
Social globalization	39%
2.1. Data on personal contact	30%
Telephone traffic (% of GDP)	13%
Transfers (% of GDP)	6%
International tourism (% of the total population)	28%
Foreign population (% of the total population)	26%
International letters (per capita)	28%
2.2. Data on information flows	35%
Internet users (per 1000 people)	25%
Television (per 1000 people)	25%
Trade-in newspapers (% of GDP)	21%
Radio (per 1000 people)	29%
2.3. Data on cultural proximity	35%
Number of Mcdonald’s restaurants (per capita)	40%
Number of Ikea stores (per capita)	41%
Trade-in books (% of GDP)	19%
Political globalization	25%
Embassies in the country	35%
Membership in International organizations	36%
Participation in UN Security Council Mission	29%

Source: Pekarskiene, I. & Susniene, R. (2011), p. 62.

Table A2. EMU membership.

EMU country	Membership year
Austria	1999
Belgium	1999
Cyprus	2008
Germany	1999
Spain	1999
Finland	1999
France	1999
Greece	2001
Ireland	1999
Italy	1999
Luxembourg	1999
Malta	2008
Netherlands	1999
Portugal	1999

Source: European Commission (2020).

Table A3. Panel ARDL Long-Run Results – Robustness check (countries joined in 1999).

Independent variables	Dependent variable: CPI
	Model (1)	Model (2)
KOFP	−0.12	−0.02
	(0.14)	(0.09)
	[-0.82]	[-0.26]
KOFE	−0.53***	−0.52***
	(0.13)	(0.09)
	[-4.21]	[-5.85]
KOFS	0.53**	0.45**
	(0.26)	(0.21)
	[2.05]	[2.14]
GDPG	1.49***	0.89***
	(0.34)	(0.19)
	[4.41]	[4.63]
EMU		8.09***
		(1.23)
		[6.56]

Standard errors in () and t-statistics in [].

***statistically significant at a 1% level of significance.

**statistically significant at a 5% level of significance.

***statistically significant at a 10% level of significance.

Source: Author’s calculations in EViews 10.

Table A4. Panel ARDL short-run results – robustness check (countries joined in 1999).

Independent variables	Dependent variable: CPI
	Model (1)	Model (2)
ECT	−0.19***	−0.27***
	(0.02)	(0.02)
	[-9.24]	[-13.37]
D(KOFP)	0.02	0.02
	(0.03)	(0.04)
	[0.57]	[0.58]
D(KOFE)	0.24***	0.31***
	(0.03)	(0.04)
	[8.87]	[8.42]
D(KOFS)	−0.30	−0.21
	(0.09)	(0.08)
	[-3.18]	[-2.56]
D(GDPG)	−0.14***	−0.12***
	(0.02)	(0.01)
	[-7.67]	[-7.97]
D(EMU)	1.58***	−1.47***
	(0.42)	(0.16)
	[3.77]	[-8.39]
C	−0.01*	17.26***
	(0.01)	(1.08)
	[-0.002]	[15.93]
Trend		−0.04**
		(0.01)
		[-3.34]

Standard errors in () and t-statistics in [].

***statistically significant at a 1% level of significance.

**statistically significant at a 5% level of significance.

***statistically significant at a 10% level of significance.

Source: Author’s calculations in EViews 10.

Table A5. Panel dynamic least squares (DOLS) – Robustness check.

Independent variables	Dependent variable: CPI
	Model (1)	Model (2)
KOFP	−0.11	−0.12
	(0.07)	(0.07)
	[-1.48]	[-1.75]
KOFE	−0.14***	−0.12***
	(0.06)	(0.06)
	[-2.29]	[-1.89]
KOFS	0.23**	0.02**
	(0.11)	(0.12)
	[2.03]	[0.23]
GDPG	0.32***	0.22**
	(0.09)	(0.08)
	[3.56]	[2.74]
EMU		3.21***
		(0.88)
		[3.65]

Standard errors in () and t-statistics in [].

***statistically significant at a 1% level of significance.

**statistically significant at a 5% level of significance.