Can trade openness be responsible for rising domestic inflation? Insights from three decades of research

Abstract

ABSTRACT Over the past 25 years, trade flows have nearly quadrupled, and a renewed concern is whether trade openness is responsible for rising domestic inflation. This paper first provides a rigorous review and evidence of trade openness on domestic inflation by using a meta-analysis utilizing 31 years of empirical studies. The measurements of inflation, country and data characteristics, some macroeconomic variables (e.g. GDP, monetary supply, exchange rate) and econometric techniques are identified as the main contributions to the heterogeneity of previous findings. After checking for the presence of publication bias, the paper shows that the average effect of trade openness on domestic inflation is very small and barely significant, and the effect heterogeneity across the results is mainly explained by the studies’ sample countries and their efforts to address the concern that trade openness might be endogenous. For studies in which endogeneity is well addressed, we find that trade openness could lead to inflation only in non-OECD countries but has no statistically significant effect in OECD countries. Therefore, the study suggests that the governments of these non-OECD countries should be aware of the side effects of trade openness.