Openness and inflation volatility: Cross-country evidence

Abstract

Recent decades have seen a considerable expansion of global trade and a simultaneous decline in inflation volatility. This paper investigates whether greater openness to trade helps achieve inflation stability. Using panel data for a sample of developing and industrial countries over the period 1961-2000, we document a negative and statistically significant effect of openness on inflation volatility. This relationship is estimated after controlling for the potential endogenity of openness, and the average rate of inflation. We conduct a battery of robuistness tests, showing in particular the robustness of our conclusions to controlling for the choice of exchange rate regime. A sub-sample analysis suggests that the relationship between openness and inflation volatility is more pronounced in developing and emerging market economies thanin OECD countires. We also identify potential channels underpinning this relationship. In particulare, we provide eveidenc that openness may promote inflation stability through dampening monetary and terms of trade shocks.

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