Trade Integration and the Phillips Curve

Abstract

This paper analyses the interconnectedness between the slope of the Phillips Curve and the degree of trade openness. A micro founded expectations - augmented Phillips Curve for a small open economy illustrates that the slope of the Phillips Curve is negatively related to the degree of trade integration in an open economy. The model shows that the monetary authority should place a higher weight on stabilising in‡ation than the output gap when the economy becomes more open to trade. Estimating a nonlinear model where the slope is time varying and depends on openness, the paper’s empirical results indicate support for the negative relationship between the degree of trade openness and the slope of the Phillips Curve across the G-7 countries.

Keywords: Output-In‡ation Trade-Off, Openness, Censored model

JEL Classification: C23, F41, G15