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How Does Global Disinflation Drag Inflation in Small Open Economies?

  • Marco Vega

    (London School of Economics & Central Bank of Peru)

  • Diego Winkelried

    (Central Bank of Peru)

This paper shows the way how persistent world inflation shocks hitting a small open economy can re-weight the importance of domestic and foreign factors in the determination of prices. In this sense, we study why the recently observed global disinflation environment may imply a weakening of the standard interest rate channel of monetary policy to affect inflation. We derive a state-dependent Phillips curve based on translog preferences that make the elasticity of substitution of domestic goods sensitive to foreign prices. With this approach we are able to replicate the dragging effect of global disinflation on domestic inflation, as experienced in small open economies such as New Zealand, Chile and Peru.

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File URL: http://econwpa.repec.org/eps/mac/papers/0403/0403008.pdf
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Paper provided by EconWPA in its series Macroeconomics with number 0403008.

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Length: 30 pages
Date of creation: 12 Mar 2004
Date of revision:
Handle: RePEc:wpa:wuwpma:0403008
Note: Type of Document - pdf; pages: 30
Contact details of provider: Web page: http://econwpa.repec.org

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