Open-economy Phillips Curve Research Articles

Can U.S. strategic petroleum reserves calm a tight market exacerbated by the Russia–Ukraine conflict?

Recent changes in global petroleum markets have driven the debate regarding the use of strategic petroleum reserves (SPRs) as a price management tool during periods marked by extreme price volatility. We examine the price management role of the U.S. SPR under typical market conditions and in extreme emergencies. Furthermore, we discuss the White House's hypotheses that (a) boosted Organization of the Petroleum Exporting Countries' (OPEC) production and releases from the U.S. SPR result in a negative pressure on U.S. gasoline inflation, and (b) crude oil releases from the U.S. SPR helps balance the global oil market. The threshold cointegration results indicate that U.S. SPR releases impact neither OPEC production nor imported input prices. We apply a hybrid open-economy Phillips curve to model gasoline inflation, accounting for backward- and forward-looking price settings, domestic and global slackness, and energy security. We distinguish between normal-, super-, and hyper-backwardation and -contango oil markets using threshold cointegration and regression techniques. Our results demonstrate that SPR releases and OPEC output increases generally decrease inflation, with a crucial exception being the hyper-backwardation market, as seen in 2021–2022. This period was characterized by severely constrained global supply buffers, including OPEC's spare capacity, exacerbated by the Russia–Ukraine conflict. For this period, we conclude that (1) the impact of OPEC production changes on gasoline inflation would be negligible, (2) excess domestic demand relative to domestic supply raises concerns about domestic energy security, and (3) the unprecedentedly large SPR drawdowns are likely to have caused the market to panic and contributed to gasoline price increases, contrary to arguments suggesting that the 2022 releases eased domestic gasoline prices. We conclude that the SPR is an ineffective price control mechanism during crises and may not have the strategic value previously thought in an extremely tight oil market.

External competition flattens the Phillips Curve

In this paper we elaborate an open economy Phillips curve (OEPC) with micro-founded analysis, in which external competition significantly impacts the domestic inflation rate. This influence is transmitted through two channels: a) the gap between the current and potential growth of imports, and b) real exchange-rate misalignment. We estimate this OEPC by applying two econometric techniques, panel regressions and PVAR accompanied by impulse/response analysis. A sample of 15 advanced economies is used with data for the period 1994-2017. The results from both methodologies endorse the validity of this theoretical relationship and suggest that international competition reduces the pricing power of domestic firms, thereby curbing inflationary pressures. We also find that the slope of the OEPC has significantly declined in the years after the Great Recession.

Inflation expectations in euro area Phillips curves

We analyze the information content of alternative inflation expectations measures, including those from consumers, firms, experts and financial markets, in the context of open economy Phillips curves. We adopt a thick modeling approach with rolling regressions and we assess the results of an out-of sample conditional forecasting exercise by means of meta regressions. The information content varies substantially across inflation expectations measures. In particular, we find that those from consumers and firms are better at predicting inflation if compared to those from experts and, especially, those from financial markets.

Mind the gap!—A monetarist view of the open-economy Phillips curve

In many countries, inflation has become less responsive to domestic factors and more responsive to global factors over the past decades. We introduce money and credit into the workhorse open-economy New Keynesian model. With this framework, we show that: (i) an efficient forecast of domestic inflation is based solely on domestic and foreign slack, and (ii) global liquidity (global money as well as global credit) is tied to global slack in equilibrium. Then, motivated by the theory, we evaluate empirically the performance of open-economy Phillips-curve-based forecasts constructed using global liquidity measures (such as G7 credit growth and G7 money supply growth) instead of global slack as predictive regressors. Using 50 years of quarterly U.S. data, we document that these global liquidity variables perform significantly better than their domestic counterparts and outperform in practice the poorly-measured indicators of global slack that global liquidity proxies for.

Mind the Gap!—A Monetarist View of the Open-Economy Phillips Curve

In many countries, inflation has become less responsive to domestic factors and more responsive to global factors over the past decades. We introduce money and credit into the workhorse open-economy New Keynesian model. With this framework, we show that: (i) an efficient forecast of domestic inflation is based solely on domestic and foreign slack, and (ii) global liquidity (global money as well as global credit) is tied to global slack in equilibrium. Then, motivated by the theory, we evaluate empirically the performance of open-economy Phillips-curve-based forecasts constructed using global liquidity measures (such as G7 credit growth and G7 money supply growth) instead of global slack as predictive regressors. Using 50 years of quarterly U.S. data, we document that these global liquidity variables perform significantly better than their domestic counterparts and outperform in practice the poorly-measured indicators of global slack that global liquidity proxies for.

Inflation Expectations in Euro Area Phillips Curves

We analyze the information content of alternative inflation expectations measures, including those from consumers, firms, experts and financial markets, in the context of open economy Phillips curves. We adopt a thick modeling approach with rolling regressions and we assess the results of an out-of sample conditional forecasting exercise by means of meta regressions. The information content varies substantially across inflation expectations measures. In particular, we find that those from consumers and firms are better at predicting inflation if compared to those from experts and, especially, those from financial markets.

Mind the Gap!—A Monetarist View of the Open-Economy Phillips Curve

In many countries, inflation has become less responsive to domestic factors and more responsive to global factors over the past decades. We introduce money and credit into the workhorse open-economy New Keynesian model. With this framework, we show that: (i) an efficient forecast of domestic inflation is based solely on domestic and foreign slack, and (ii) global liquidity (global money as well as global credit) is tied to global slack in equilibrium. Then, motivated by the theory, we evaluate empirically the performance of open-economy Phillips-curve-based forecasts constructed using global liquidity measures (such as G7 credit growth and G7 money supply growth) instead of global slack as predictive regressors. Using 50 years of quarterly U.S. data, we document that these global liquidity variables perform significantly better than their domestic counterparts and outperform in practice the poorly-measured indicators of global slack that global liquidity proxies for.

Phillips Curve for the Asian Economies: A Nonlinear Perspective

ABSTRACT This paper examines the impact of exchange-rate movements on inflation in eight Asian countries. Results from an open-economy Phillips curve are; first, the Markov-switching open-economy model confirm that the two-state Phillips curve outperforms alternative models to study inflation dynamics. There is considerable heterogeneity in the pass-through estimates for Asian countries, with Singapore exhibiting the lowest exchange rate pass-through (ERPT). Regime-dependent pass-through estimates are sensitive to average inflation and it should be factored in when forecasting inflation rates. Second, the extent of pass-through is considerably lower and far from complete in a low-inflation regime, endorsing Taylor hypothesis. Third, in the majority of the countries, we find support for global disinflation in domestic inflation that has strengthened over time. The main takeaway is that globalization matters for Asian inflation dynamics.

Exploring the Nexus between Inflation and Globalization Under Inflation Targeting Through the Lens of New Zealand's Experience

We investigate empirically the inflation dynamics in New Zealand, a small open economy and a pioneer in inflation targeting, under various open-economy Phillips curve specifications. Our forecasting exercise suggests that open-economy Phillips curves under standard measures of global slack do not help forecast domestic inflation, possibly indicating measurement problems with global slack itself. In turn, under a stable inflation target we still find that (i) global inflation and (ii) global inflation and oil prices have information content for headline CPI and core CPI inflation over the 1997:Q3-2015:Q1 period and appear to be reliable proxies for global slack in forecasting inflation.

Exploring the Nexus Between Inflation and Globalization Under Inflation Targeting Through the Lens of New Zealand’s Experience

We investigate empirically the inflation dynamics in New Zealand, a small open economy and a pioneer in inflation targeting, under various open-economy Phillips curve specifications. Our forecasting exercise suggests that open-economy Phillips curves under standard measures of global slack do not help forecast domestic inflation, possibly indicating measurement problems with global slack itself. In turn, under a stable inflation target we still find that (i) global inflation or (ii) global inflation or oil prices have information content for headline CPI and core CPI inflation over the 1997:Q3-2015:Q1 period and appear to be reliable proxies for global slack in forecasting inflation.

Global slack and open economy Phillips curves – A province-level view from China

The “global slack hypothesis” implies that greater integration of the world economy, i.e. globalisation, should have made inflation more responsive to global than domestic economic slack. Many previous studies have accordingly estimated national inflation equations with measures of global output gaps. We use three and a half decades of subnational data from China's provinces to test the global slack hypothesis. Using tests for non-nested regressions, for many provinces we can reject a Phillips curve with a province-level measure of economic slack against a model with China's national output gap, which is consistent with the hypothesis. We also show that the real exchange rate matters for inflation dynamics in many Chinese provinces, in particular those most open to international trade. In addition to supporting the global slack hypothesis, our results emphasise the importance of cross-border factors for China's inflation developments.

Inflation as a Global Phenomenon -- Implications for Forecasting

We evaluate the performance of inflation forecasts based on the open-economy Phillips curve by exploiting the spatial pattern of international propagation of inflation. We model these spatial linkages using global inflation and either domestic slack or oil price fluctuations, motivated by a novel interpretation of the forecasting implications of the workhorse open-economy New Keynesian model (Martinez-Garcia and Wynne (2010), Kabukcuoglu and Martinez-Garcia (2014)). We find that incorporating spatial interactions yields significantly more accurate forecasts of local inflation in 14 advanced countries (including the U.S.) than a simple autoregressive model that captures only the temporal dimension of the inflation dynamics.

Does Domestic Output Gap Matter for Inflation in a Small Open Economy?

In the paper we have investigated to what extent the behaviour of CPI inflation depends on changes in domestic economic activity in Polish economy which is usually described as a small open economy. We conducted a disaggregated analysis using price indices at the COICOP 4-digit level. We specified a small open economy Phillips curve for individual price indices. Additionally we investigated the exchange rate pass through at COICOP group levels. We found that more than 50 per cent of the categories react to the output gap. According to our expectations the categories which are mostly linked to the output gap are services but also non-durable goods. We identified that only small share of prices of durable and semi-durable goods react to domestic demand which can be explained to some extent by globalization process. We also found that more than one third of the price indices respond to exchange rate movements and/or foreign inflation. The impact of exchange rate is most substantial for durable and semi-durable goods which are to large extent perceived as tradable goods. Finally we aggregated the price indices for items sensitive to domestic economic activity and formed an index which, taking into account uncertainty and substantial lags in calculating output gap, may be used as an alternative measure of domestic inflationary pressure.

Determination of inflation in an open economy Phillips curve framework: the case of developed and developing Asian countries

This paper investigates the determination of inflation in the framework of an open economy forward-looking as well as conventional backward-looking Phillips curve for eight Asian countries – Japan, Hong Kong, Korea, Singapore, Philippines, Thailand, China Mainland and India. Using quarterly data from the 1990s to 2005 and applying the instrumental variables estimation technique, we find that the output gap is significant in explaining the inflation rate in almost all the countries. Furthermore, at least one measure of international competitiveness has a statistically significant influence on inflation in all the countries. The differences in the developed and developing world are highlighted by the significance of agriculture related supply shocks in determining inflation in the case of developing countries. For all countries, the forward-looking Phillips curve provides a better fit compared to the backward-looking variant.

Estimating open economy Phillips curves for the euro area with directly measured expectations

This paper examines euro-area inflation dynamics by estimating open economy New Keynesian Phillips curves based on the assumption that all imports are intermediate goods. Instead of imposing rational expectations a priori, Consensus Economics survey data and OECD inflation forecasts are used to proxy inflation expectations. The results suggest that, compared with a closed economy New Keynesian Phillips curve, euro-area inflation dynamics are captured better by the open economy specification. Moreover, in the open economy context, even if we allow for persistence in expectations, the hybrid specification of the New Keynesian Phillips curve is needed in order to properly capture the euro-area inflation process.

Estimating Open Economy Phillips Curves for the Euro Area with Directly Measured Expectations

This paper examines euro area inflation dynamics by estimating open economy New Keynesian Phillips curves based on the assumption that all imports are intermediate goods. Instead of imposing rational expectations a priori, Consensus Economics survey data and OECD inflation forecasts are used to proxy inflation expectations. The results suggest that, compared with a closed economy New Keynesian Phillips curve, euro area inflation dynamics are better captured by the open economy specification. Moreover, in the open economy context, and even if we allow for persistence in expectations, the hybrid specification of the New Keynesian Phillips curve is needed in order to capture the euro area inflation process properly. We also provide some evidence that in recent years of low and stable inflation, euro area inflation dynamics have become more forward-looking and the link between inflation and domestic demand has weakened (ie the euro area Phillips curve has flattened). On the other hand, in low-inflation euro area countries the inflation process seems to have been more forward-looking already since the early 1980s.

Is there an exchange rate channel in the forward‐looking Phillips curve? A theoretical and empirical investigation

This paper shows how the exchange rate affects the price‐setting behavior of monopolistically competitive firms in the sticky price framework that gives rise to a forward‐looking Phillips Curve at the aggregate level. The open economy Phillips Curve differs from its closed economy counterpart in that the real exchange rate exerts a direct effect on domestic inflation. The exchange rate channel in the Phillips Curve is pivotal in determining the optimal policy setting in an open economy. On balance, we find only scant empirical evidence for the existence of a direct exchange rate channel in the Phillips Curve in a sample of six OECD countries. Indeed, the forward‐looking Phillips Curve does not receive much backing from the data.

Phillips curve forecasting in a small open economy

Using data for Australia and New Zealand, this paper finds that the open economy Phillips curve forecasts poorly relative to an autoregressive benchmark. However, its performance improves markedly when a sectoral Phillips curve is used, which weights together a closed economy Phillips curve for the non-tradable sector with an open economy Phillips curve for the tradable sector.

The Timeless Perspective vs. Discretion: Theory and Monetary Policy Implications for an Open Economy

This paper proposes an open-economy Phillips Curve that features a real exchange rate channel. The resulting target rule under optimal policy from a timeless perspective (TP) involves additional history dependence in the form of lagged inflation. The target rule also depends on the discount factor as well as IS and Phillips Curve parameters. This is in sharp contrast to a closed economy where the target rule depends only on the change in the output gap, the current rate of inflation and the structural parameter in the Phillips Curve. Because of the additional history dependence in an open economy, price level targeting is no longer consistent with optimal policy. If a real exchange rate channel does not exist in the Phillips Curve, monetary policy eases in the wake of a positive cost-push disturbance under policy from a TP and is thus diametrically opposed to same under discretion. Maximum gains accrue from commitment relative to discretion in an open economy where the real exchange rate is absent from the Phillips Curve and the policymaker places strong emphasis on maintaining price stability.

Stabilising Properties of Discretionary Monetary Policies in a Small Open Economy

This article sets out a simple New Keynesian open-economy model and shows that the conduct of discretionary monetary policy in an open economy differs substantially from the closedeconomy framework. The article shows analytically that the existence of the direct exchange rate channel in the open economy Phillips Curve impairs the perfect stabilising property of monetary policy in the face of demand-side disturbances under domestic inflation targeting. If CPI inflation is instead the target, then the perfect stabilising property of monetary policy breaks down even in the absence of the direct exchange rate channel in the Phillips Curve.