Why Do Inflation Rates Vary Across Countries?
67 Pages Posted: 18 Oct 2022 Last revised: 12 Dec 2023
Date Written: October 16, 2022
We build an APT-like factor model for consumer price fluctuations across 181 countries and regions from January 1990 to February 2022. The sizable cross-sectional heterogeneity in inflation is well explained by the differential exposures (betas) to a set of common global factors, including three procyclical factors, i.e., energy price index, agriculture price index, and composite leading indicators, and three countercyclical factors, i.e., global unemployment rate, precious metals price index, and world uncertainty index. The main finding is that economies with procyclical inflation generally experience higher inflation than those with countercyclical inflation. The empirical estimates are significant and robust across various model specifications, alternative rolling-window analyses, and additional global factors. I propose an interpretation from a consumer behavior perspective for this observation: if other conditions are similar, consumers tend to adopt more accommodating consumption plans in economies with procyclical inflation due to the ``hedging effect'' of declining inflation in adverse economic conditions. Conversely, in economies with countercyclical inflation, consumers may display greater caution and a higher propensity to save rather than spend in everyday life, as such economies are more ``risky'' to consumers. Consequently, consumers' asymmetric aversion to rising inflation in economies with varying inflation cycle characteristics results in differing aggregate demand for consumption and, thus, diverse inflation rates across economies. This finding also contrasts with those from cross-sectional asset pricing studies. Despite divergent rationales, factor prices (lambdas) exhibit the same sign - positive for procyclical factors and negative for countercyclical factors.
Keywords: Inflation Cyclicality, World Business Cycle, Common Global Factors, Aggregate Consumption Demand, Fama–MacBeth Regression
JEL Classification: E31, E32, E70, G12, C55
Suggested Citation: Suggested Citation