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Openness and inflation volatility: Cross-country evidence

Recent decades have seen a considerable expansion of global trade and a simultaneous decline in inflation volatility. This paper investigates whether greater openness to trade helps achieve inflation stability. Using panel data for a sample of developing and industrial countries over the period 1961-2000, we document a negative and statistically significant effect of openness on inflation volatility. This relationship is estimated after controlling for the potential endogeneity of openness, and the average rate of inflation. We conduct a battery of robustness tests, showing in particular the robustness of our conclusions to controlling for the choice of exchange rate regime. A sub-sample analysis suggests that the relationship between openness and inflation volatility is more pronounced in developing and emerging market economies than in OECD countries. We also identify potential channels underpinning this relationship. In particular, we provide evidence that openness may promote inflation stability through dampening monetary and terms of trade shocks.

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File URL: http://www.nuffield.ox.ac.uk/economics/papers/2005/w14/Maydraft2.pdf
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Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2005-W14.

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Length: 48 pages
Date of creation: 15 Mar 2005
Date of revision:
Handle: RePEc:nuf:econwp:0514
Contact details of provider: Web page: http://www.nuff.ox.ac.uk/economics/

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