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How Does Global Disinflation Drag Inflation in Small Open Economies?

34 Pages Posted: 19 Apr 2004  

Marco Vega

Central Bank of Peru

Diego Winkelried

University of Cambridge - Faculty of Economics and Politics; Central Reserve Bank of Peru

Date Written: November 8, 2004

Abstract

This paper shows the way how persistent world inflation shocks hitting a small open economy can re-weight the importance of domestic and foreign factors in the determination of prices. In this sense, we study why the recently observed global disinflation environment may imply a weakening of the standard interest rate channel of monetary policy to affect inflation. We derive a state-dependent Phillips curve based on translog preferences that make the elasticity of substitution of domestic goods sensitive to foreign prices. With this approach we are able to replicate the dragging effect of global disinflation on domestic inflation, as experienced in small open economies such as New Zealand, Chile and Peru.

Keywords: Monetary policy, Phillips curve, translog preferences

JEL Classification: E31, E52

Suggested Citation

Vega, Marco and Winkelried, Diego, How Does Global Disinflation Drag Inflation in Small Open Economies? (November 8, 2004). Available at SSRN: https://ssrn.com/abstract=517004 or http://dx.doi.org/10.2139/ssrn.517004

Marco Vega (Contact Author)

Central Bank of Peru ( email )

Research Division
Jiron Miroquesada 441
Lima, Lima 1
Peru
++511 6132042 (Phone)
++511 428 8113 (Fax)

HOME PAGE: www.bcrp.gob.pe

Diego Winkelried

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Central Reserve Bank of Peru ( email )

Miroquesada 411
Lima
Peru

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