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The global slack hypothesis

  • Enrique Martinez-Garcia
  • Mark A. Wynne

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.

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Volume (Year): (2010)
Issue (Month): Sep ()
Pages:

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Handle: RePEc:fip:feddst:y:2010:i:sep:n:10
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  1. Charles Engel, 2011. "Currency Misalignments and Optimal Monetary Policy: A Reexamination," American Economic Review, American Economic Association, vol. 101(6), pages 2796-2822, October.
  2. Stefania Albanesi & V.V. Chari & Lawrence J. Christiano, . "Expectation Traps and Monetary Policy," Working Papers 198, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  3. Katharine S. Neiss and Edward Nelson, 2001. "The Real Interest Rate Gap as an Inflation Indicator," Computing in Economics and Finance 2001 145, Society for Computational Economics.
  4. Glenn D. Rudebusch, 2005. "Monetary policy inertia: fact or fiction?," Working Paper Series 2005-19, Federal Reserve Bank of San Francisco.
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  8. James A. Orr, 1994. "Has excess capacity abroad reduced U.S. inflationary pressures?," Quarterly Review, Federal Reserve Bank of New York, issue Sum, pages 101-106.
  9. Bentolila, Samuel & Dolado, Juan J. & Jimeno, Juan F, 2007. "Does Immigration Affect the Phillips Curve? Some Evidence for Spain," CEPR Discussion Papers 6604, C.E.P.R. Discussion Papers.
  10. Richard W. Evans, 2007. "Is openness inflationary? Imperfect competition and monetary market power," Globalization and Monetary Policy Institute Working Paper 01, Federal Reserve Bank of Dallas.
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