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The global slack hypothesis

Author

Listed:
  • Enrique Martinez-Garcia
  • Mark A. Wynne

Abstract

We illustrate the analytical content of the global slack hypothesis in the context of a variant of the widely used New Open-Economy Macro model of Clarida, Galí, and Gertler (2002) under the assumptions of both producer currency pricing and local currency pricing. The model predicts that the Phillips curve for domestic CPI inflation will be flatter under most plausible parameterizations, the more important international trade is to the domestic economy. The model also predicts that foreign output gaps will matter for inflation dynamics, along with the domestic output gap. We also show that the terms of trade gap can capture foreign influences on domestic CPI inflation in an open economy as well. When the Phillips curve includes the terms of trade gap rather than the foreign output gap, the response of domestic inflation to the domestic output gap is the same as in the closed-economy case ceteris paribus. We also note the conceptual and statistical difficulties of measuring the output gaps and suggest that measurement error bias can be a serious concern in the estimation of the open-economy Phillips curve relationship with reduced-form regressions when global slack is not actually observable.

Suggested Citation

  • Enrique Martinez-Garcia & Mark A. Wynne, 2010. "The global slack hypothesis," Staff Papers, Federal Reserve Bank of Dallas, issue Sep.
  • Handle: RePEc:fip:feddst:y:2010:i:sep:n:10
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    File URL: http://www.dallasfed.org/assets/documents/research/staff/staff1002.pdf
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    References listed on IDEAS

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    4. Mark A. Wynne & Erasmus K. Kersting, 2007. "Openness and inflation," Staff Papers, Federal Reserve Bank of Dallas, issue Apr.
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    6. Neiss, Katharine S. & Nelson, Edward, 2003. "The Real-Interest-Rate Gap As An Inflation Indicator," Macroeconomic Dynamics, Cambridge University Press, vol. 7(02), pages 239-262, April.
    7. Charles Engel, 2011. "Currency Misalignments and Optimal Monetary Policy: A Reexamination," American Economic Review, American Economic Association, vol. 101(6), pages 2796-2822, October.
    8. Fabio Rumler, 2007. "Estimates of the Open Economy New Keynesian Phillips Curve for Euro Area Countries," Open Economies Review, Springer, vol. 18(4), pages 427-451, September.
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    Citations

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    Cited by:

    1. repec:mes:emfitr:v:53:y:2017:i:8:p:1812-1835 is not listed on IDEAS
    2. Zhang, Chengsi & Zhou, You, 2016. "The Global Slack Hypothesis: New Evidence from China," International Review of Economics & Finance, Elsevier, vol. 42(C), pages 339-348.
    3. repec:eee:dyncon:v:87:y:2018:i:c:p:46-73 is not listed on IDEAS
    4. Enrique Martinez-Garcia & Mark A Wynne, 2013. "Global slack as a determinant of US inflation," BIS Papers chapters,in: Bank for International Settlements (ed.), Globalisation and inflation dynamics in Asia and the Pacific, volume 70, pages 93-98 Bank for International Settlements.
    5. Martínez-García, Enrique & Vilán, Diego & Wynne, Mark A., 2012. "Bayesian estimation of NOEM models: identification and inference in small samples," Globalization and Monetary Policy Institute Working Paper 105, Federal Reserve Bank of Dallas, revised 01 Mar 2012.
    6. Borio, Claudio, 2014. "The financial cycle and macroeconomics: What have we learnt?," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 182-198.
    7. Chen, Changsheng & Girardin, Eric & Mehrotra, Aaron, 2017. "Global slack and open economy Phillips curves – A province-level view from China," China Economic Review, Elsevier, vol. 42(C), pages 74-87.
    8. Gregor Schwerhoff & Mouhamadou Sy, 2013. "The non-monetary side of the global disinflation," PSE Working Papers halshs-00564957, HAL.
    9. Gregor Schwerhoff & Mouhamadou Sy, 2014. "The Non-Monetary Side of the Global Disinflation," Open Economies Review, Springer, vol. 25(2), pages 337-371, April.
    10. Aleksandra Hałka & Jacek Kotłowski, 2017. "Global or Domestic? Which Shocks Drive Inflation in European Small Open Economies?," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 53(8), pages 1812-1835, August.

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