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Article Excerpt
"The integration of rapidly industrialized economies into the global trading system clearly has had important effects on the prices of both manufactures and commodities, reinforcing the need to monitor international influences on the inflation process." (1)
HAS INFLATION BECOME more globalized? Recently this question has attracted substantial interest among monetary policymakers. A popular tenet is that the increased degree of trade integration among the industrialized economies makes it likely that international factors play a significant role in determining national inflation rates. As emphasized by Bernanke (2006), the link between trade integration and inflation may work via two complementary channels: a direct (terms of trade) effect due to lower import prices, and an indirect (pro-competitive) effect due to competitive pressures, lower markups, and strategic complementarity (reduced pricing power of domestic firms). (2) From a monetary policy perspective, if global influences are indeed important, it is conceivable that domestic inflation rates may (at least partly) escape the control of national central banks.
The purpose of this paper is twofold. First, we aim at providing a quantitative assessment of the relative contribution of aggregate international factors (shocks) in driving the inflation rates of a large cross-section of disaggregated consumer prices in four Organisation for Economic Co-operation and Development (OECD) countries. For this purpose, we construct a measure of international commonality at the product level, defined, for each inflation series, as the share of the variance attributable to purely international common factors. We find that, on average, and in the sample 1991-2004, international common factors explain between 15% and 30% of the variation in disaggregated consumer price inflation rates. Given the highly disaggregated composition of our panel, we interpret these numbers as a sizeable lower bound for the contribution of global forces to the dynamics of disaggregated sectoral prices.
Second, we test empirically the relationship between international commonality and sectoral trade openness. The latter is defined (for each sector in our cross-section) as the share of imports and exports in sectoral output, respectively, from and toward the countries of our sample. We find a strongly positive and statistically significant relationship between international commonality of inflation and sectoral trade openness, providing support for the (business-cycle) link between trade integration and exposure of inflation to global forces.
A research literature focusing on the global dimension of inflation has developed only recently. This literature is the counterpart of an already well-developed literature on the international synchronization of business cycles (namely synchronization in GDP growth fluctuations) (see Kose, Otrok, and Whiteman 2003, IMF WEO 2006, ch. 4). Wang and Wen (2007) find that the average cross-country correlation of inflation in industrialized countries is much larger than the cross-country correlation of output growth. Borio and Filardo (2006) point the attention to "global slack" as a determinant of national inflation rates. (3) Ciccarelli and Mojon (2007) argue that, historically, inflation in industrialized countries has been largely a global phenomenon. They estimate that the CPI inflation rates of a large sample of OECD countries have a common factor that alone accounts for nearly 70% of their variance. Mumtaz and Surico (2007) compare the role of national versus international factors in driving the dynamics of inflation in a sample of industrialized countries. They conclude that while international factors have proved particularly important in reducing the level and the persistence of the inflation process in those countries, the increased volatility of inflation of the seventies was by and large a country-specific phenomenon.
All aforementioned contributions addressing the general theme of globalization and inflation share a common element: they look at aggregate price inflation data. (4) By contrast, in this paper, we test for the presence of common international components driving the inflation dynamics of highly disaggregated consumer price data. In particular, our data set consists of product-category monthly price series covering the CPI in a sample of four industrialized countries: United States, Germany, France, and United Kingdom. By product category, we mean a level of disaggregation higher than sectoral price data but lower than individual scanner data.
Looking at product-category data yields several potential advantages. First, it allows to explore the relationship between international commonality and economic characteristics of the sector. In this work we focus, in particular, on the role of sectoral trade openness. Second, it allows to balance the information of a rich cross-section with a sizeable time series dimension. Both features are in fact quite relevant to our analysis, and cannot be usually combined in panel data obtained from (even more disaggregated) individual scanner observations (see, e.g., Bils and Klenow 2004, Nakamura and Steinsson 2006, Kehoe and Midrigan 2007). Third, it allows to compute a lower bound for the contribution of international factors to the variance of consumer product inflation rates. That contribution is in fact sensitive to the degree of (dis)aggregation present in the sample, with more aggregate data boosting the role of common components in general. This feature most likely rationalizes the result found by Ciccarelli and Mojon (2007) with aggregate CPI inflation data.
We first estimate a linear dynamic factor model applied to a cross-section of 948 consumer prices expressed in local currency, and extract those factors that are common to the international panel (see, e.g., Forni et al. 2000). One can think of common factors as encompassing all those unobserved aggregate components that drive the co-movement of prices across countries, ranging from variations in policy to real and nominal aggregate shocks (and including, potentially, also the cross-country spillover effects of country-specific shocks). We reach the following conclusions. First, one international common factor explains, on average, between 15% and 30% of the variance of the consumer product inflation rates, with this range depending on the type of transformation applied to the data, i.e., month-on-month as opposed to year-on-year log changes (m.o.m. and y.o.y, henceforth). Our result contrasts sharply with the one of Ciccarelli and Mojon (2007), who estimate that one common factor alone accounts for 70% of the variance of aggregate CPI inflation in a sample of OECD countries. This contrast suggests that, in general, aggregation matters when it comes to estimating the contribution of common factors to the total variance of a panel. Since the cross-section we employ in this study is large and our data are significantly more disaggregated, our estimate should be best viewed as a lower bound for the role of international factors in driving the variations of consumer price inflation.
Second, the contribution of international common factors varies across countries: it is the lowest in the United States (between 9 and 16%) and the highest in Germany (between 20% and 42%).
Third, the degree of international commonality of sectoral inflation is positively and significantly related to the trade intensity of the sector. We define the latter as the sum of sectoral imports and exports (relative to sectoral output), respectively, from and toward the countries of our...
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