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Tailwinds and headwinds: how does growth in the BRICs affect inflation in the G7?

  • Lipinska, Anna

    ()

    (Bank of England)

  • Millard, Stephen

    ()

    (Bank of England)

In this paper, we analyse the impact of a persistent productivity increase in a set of countries – which we think of as the BRIC economies – on inflation in their trading partners, the G7. In particular we want to understand conditions under which this shock can lead to tailwinds or headwinds in the economies of trading partners. We build a three-country DSGE model in which there are two oil-importing countries (home and foreign) and one oil-exporting country. We perform several experiments where we try to disentangle the importance of different factors that can shape inflation dynamics in the home country when the foreign country is hit by a persistent productivity shock. These factors are wage stickiness, the role of the oil sector and its share in both consumption and production, foreign monetary policy and the degree of completeness of financial markets. We find that the tailwinds effect, lowering inflation in the home economy, dominates the headwinds effect as long as there is scope for borrowing and lending across countries and the foreign country’s production is not too oil intensive.

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Paper provided by Bank of England in its series Bank of England working papers with number 420.

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Length: 30 pages
Date of creation: 15 Apr 2011
Date of revision:
Handle: RePEc:boe:boeewp:0420
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  1. Christopher Knittel & Daniel Sperling, 2006. "Evidence of a Shift in the Short-Run Price Elasticity of Gasoline Demand," Working Papers 625, University of California, Davis, Department of Economics.
  2. Lutz Kilian, 2009. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," American Economic Review, American Economic Association, vol. 99(3), pages 1053-69, June.
  3. Pierpaolo Benigno, 2009. "Price Stability with Imperfect Financial Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 121-149, 02.
  4. Argia M. Sbordone, 2008. "Globalization and inflation dynamics: the impact of increased competition," Staff Reports 324, Federal Reserve Bank of New York.
  5. Alessia Campolmi, 2009. "Oil price shocks: Demand vs Supply in a two-country," 2009 Meeting Papers 877, Society for Economic Dynamics.
  6. Deren Unalmis & Ibrahim Unalmis & Derya Filiz Unsal, 2008. "Oil Price Shocks, Macroeconomic Stability and Welfare in a Small Open Economy," Working Papers 0802, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  7. Luca Guerrieri & Christopher Erceg & Martin Bodenstein, 2008. "Oil Shocks and External Adjustment," 2008 Meeting Papers 945, Society for Economic Dynamics.
  8. Benigno, Gianluca & Benigno, Pierpaolo & Ghironi, Fabio, 2007. "Interest rate rules for fixed exchange rate regimes," Journal of Economic Dynamics and Control, Elsevier, vol. 31(7), pages 2196-2211, July.
  9. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
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