Do Adverse Global Trade Shocks Impact the Trade-off Between the Inflation and Output-Gap Volatilities

Abstract

We examine the impact of negative global trade shocks on labour market conditions, inflation and output-gap volatility trade-off. This chapter establishes that a negative global trade shock impacts the trade-off between output-gap and inflation volatilities (that is, the Taylor curve) and labour market conditions tighten. Furthermore, we establish that labour markets adjust more to negative global trade shocks compared to the output-gap and inflation volatilities. Negative shocks to global demand via the trade channel exert pronounced adverse effects on labour market conditions than the Taylor curve. In addition, a disaggregated analysis of the labour market conditions index shows that employment growth (quantity) adjusts more than remuneration per worker (price) to negative global trade shocks. However, on a comparative basis, the negative global trade shocks induce a large proportion of movements in output growth volatility and labour market conditions than in inflation volatility. This suggests that negative global trade shocks are transmitted more via the output growth and employment growth channels than the inflation channel. At the same time, the exchange rate depreciation following a negative trade shock poses risks to the inflation and output growth volatilities and this neutralises the policy rate responses to inflation shocks.