TITLE:
Convex Phillips Curve Explaining Openness and Inflation Nexus
AUTHORS:
S. Ali Shah Syed, Helène Syed Zwick
KEYWORDS:
Globalization, Import Prices, Trade Openness, Inflation, Phillips Curve
JOURNAL NAME:
Theoretical Economics Letters,
Vol.5 No.6,
December
23,
2015
ABSTRACT: We study the theoretical nexus between inflation and
trade openness in the presence of a non-linear Phillips curve. Phillips curve explains the
inverse relationship between unemployment and inflation; however, the open
economy macroeconomic models usually propose that the slope of the trade-off
should be related to the extent of trade openness. The role of openness as
a check on inflation has recently attracted attention of many [1]. The parallelism
between the recent globalization wave and the fall in inflation has led to a
perception that the determinants of the slowdown in inflation were not only the
domestic ones but could partly be due to increased trade openness. This study
describes this relationship considering a non-linear Phillips curve. Using the
conventional Phillips curve approximated by Cobb-Douglas model we confirm the
earlier observations regarding the existence of a significant impact of
openness on inflation. The interesting contribution of this study is not only
to establish the trade-openness and inflation nexus but also to identify the
relevant channels through which openness impacts inflation. Our model predicts
that in the current scenario of increased openness a non-linear symmetric loss
function may still prevail, but for the policy purposes it necessitates to
consider domestic and foreign propensities to import and the exchange rate
sensitivity to inflation. In addition, the integration of the international
markets would result into an even more important role of exchange rate dynamics
as a response to the rising international trade. We find that in the presence
of a convex Phillips curve any upward variation in the foreigners’ propensity
to import would place a downward pressure on domestic inflation, provided that
the current and the lagged rate of unemployment are less than minimum
unemployment rate. Our model, while assessing the short run dynamics, also
suggests that increased openness results into a complex divide among different
economies, due to their sizes and structures. Investigating such a relationship
as an extension of this study for different economic groups could reveal
further interesting facts.