What Drives Inflation in the World?

This paper evaluates the impact of non-monetary factors on inflation for a sample of 97 countries over the period 1975-2005. We complement and extend the existing literature in the following dimensions: (i) we assemble a comprehensive set of inflation determinants classified in 5 groups — high inflation and persistence, monetary and exchange rate regimes, openness, structural variables and institutions, and business-cycle-related variables. (ii) We estimate broad specification using alternative econometric techniques and frequencies of data (e.g. annual and 5-year-averages) to assess separately for short -term and long-term inflation dynamics. (iii) We test the sensitivity of our results to different country groups and over time. Our findings mainly show that: (a) discipline and credibility enhancing effects are crucial in lowering inflation. We find that countries that adopted either inflation targeting or fixed exchange rate regimes attain lower inflation rates. Financial openness and healthy fiscal balances also exerted a disciplinary effect on inflation in the short run. (b) Countries with higher income per capita have lower inflation rates. (c) Interestingly, domestic output gap has a positive effect that is higher in industrial countries than in developing ones. (d) We fail to find a significant effect of globalization —as proxied by the foreign output gap— on domestic inflation.