International Inflation Synchronization and Implications

KDI Journal of Economic Policy 2020, 42(2):57–84

29 Pages Posted: 21 Sep 2020

See all articles by Sora Chon

Sora Chon

Korea Development Institute (KDI)

Date Written: May 30, 2020

Abstract

This study analyzes global inflation synchronization and derives policy implications for the Korean economy. Unlike previous studies that assume a single global inflation factor, this study investigates if inflation in Korea can be explained further by other global inflation factors. Our principal component analysis provides three principal components for global inflation that are linked to the Korea inflation rate ― the first component is closely related to OECD inflation, and the second and third components reflect China’s inflation. This study empirically demonstrates via in-sample fitting and out-of-sample forecasting that the three principal components of global inflation play a significant role in explaining and predicting Korean inflation in the short-term, while their role is limited in the mid-term. Domestic macroeconomic variables are found to be more important for the mid-term movements of the Korean inflation rate. The empirical results here suggest that the Bank of Korea should focus more on domestic economic conditions than on global inflation when implementing monetary policy because global factors are likely to be already reflected in domestic macro-variables in the mid-term.

Keywords: Inflation Rates, Monetary Policy, Forecasting, Principal Component Model, LASSO

JEL Classification: E31, E37, E5

Suggested Citation

Chon, Sora, International Inflation Synchronization and Implications (May 30, 2020). KDI Journal of Economic Policy 2020, 42(2):57–84, Available at SSRN: https://ssrn.com/abstract=3693523

Sora Chon (Contact Author)

Korea Development Institute (KDI) ( email )

263 Namsejong-ro
Sejong-si 30149
Korea, Republic of (South Korea)

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