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Globalization, the output-inflation tradeoff and inflation

  • Badinger, Harald

This paper provides comprehensive evidence on the relation between inflation and globalization, defined here as trade and financial openness, using a large cross-section of 91 countries over the period 1985-2004. We establish two main empirical regularities: both higher trade and financial openness (i) reduce central banks' inflation bias, yielding lower average inflation and (ii) are associated with a larger output-inflation tradeoff. This evidence is at odds with the standard Barro-Gordon framework, which would require globalization to have a negative effect on the output-inflation tradeoff to yield lower equilibrium inflation, but it is consistent with a recent strand of new Keynesian models emphasizing the role of imperfect competition and nominal rigidities. Our findings also support the relevance of the time-inconsistency hypothesis, which underlies the theoretical models predicting a relation between globalization and inflation. For the OECD subsample, however, we do not find an effect of openness on inflation (the output-inflation tradeoff), suggesting that these countries have created an institutional framework for central banks that eliminates distortions due to the time-inconsistency problem.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 53 (2009)
Issue (Month): 8 (November)
Pages: 888-907

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Handle: RePEc:eee:eecrev:v:53:y:2009:i:8:p:888-907
Contact details of provider: Web page: http://www.elsevier.com/locate/eer

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