Inflaion and globalisaion: a modelling perspecive Charles Engel 1 Absrac This paper examines some sandard open-economy New Keynesian models o address he quesion of how globalisaion affecs he inflaion process Specifically, i invesigaes how he Phillips curve for consumer price inflaion in a counry is affeced by openness, and how he opimal choice of moneary policy is influenced by openness The paper compares models ha assume producer currency pricing wih ones ha assume local currency pricing I also considers he role of financial marke compleeness Keywords: open-economy Phillips curve; moneary policy; exchange rae policy JEL classificaions: F41, F42, E61 1 Universiy of isconsin and NBE BIS Papers No 70 99
In he pas decade here has been much discussion among policymakers and policy-oriened economiss on he role of globalisaion in inflaion Inflaion is a moneary phenomenon, and a general equilibrium phenomenon The effecs of globalisaion on inflaion depend on he srucure of he macroeconomy and on moneary policies For example, suppose a counry has is own currency, and i successfully and rigidly arges is inflaion rae for example, a a 2% annual rae Globalisaion will no affec he inflaion rae a all under his scenario Inflaion is 2% no maer how globalized i becomes In his noe, in he conex of a simple open-economy New Keynesian macroeconomic model, we sugges hree differen ways of hinking abou he effecs of an economy s openness on inflaion: (1) How openness migh affec he policymaker s assessmens of he relaive coss of inflaion, oupu gaps and possibly exchange rae misalignmens (ha is, how he policymaker s objecives are influenced by openness) (2) How he Phillips curve is affeced by openness (ha is, how he consrains facing he policymaker are influenced by globalisaion) (3) How he equilibrium inflaion rae, which depends on he policy choices and he Phillips curve, is influenced by globalisaion One way o assess he poenial effecs of globalisaion is o build a full and empirically plausible general equilibrium macroeconomic model, and hen assess how he sochasic process for inflaion would change under he hypoheical experimen of he economy becoming more open For a given se of exogenous shocks, one could predic how he uncondiional mean of inflaion changes, and how he dynamics of inflaion changes in response o various shocks hile ha approach is cerainly useful, his noe examines he radeoffs in he policymaker s loss funcion and in he Phillips curve in he simple wo-counry open economy New Keynesian model of Engel (2011) There are wo direc channels hrough which he world economy influences local inflaion hrough he foreign oupu gap, and hrough exchange rae changes e propose a logical framework for assessing he quesion and o clarify some of he discussion in he lieraure, bu no necessarily o provide a realisic answer To illusrae he poin of his noe, consider Ball (2006), who inveighs agains much of he lieraure on his opic, which he views as having commied many logical fallacies Ball concludes ha globalisaion does no play much, if any, role in inflaion deerminaion In some conexs, ha conclusion is cerainly correc For example, he cenral bank ha always rigidly arges 2% inflaion presumably does no consider here o be a radeoff among objecives concerning he oupu gap, inflaion and exchange rae misalignmen is only objecive is o minimize deviaions from is arge inflaion rae In his case, as noed already, here is no influence of globalisaion on inflaion However, real world cenral banks mus make radeoffs, and globalisaion influences hese radeoffs Ball does no examine he quesion in he conex of a model Consider Ball s criicism of Borio and Filardo (2007), who esimae a Phillips curve ha includes he foreign as well as he domesic oupu gap: This sory is dubious on boh heoreical and empirical grounds In mainsream heories, oupu affecs inflaion because i affecs firms marginal coss ises in marginal cos are passed hrough ino higher prices Marginal coss for a counry s firms depend on heir own oupu levels, no foreign oupu However, in mainsream heory, such as he model in Engel (2011), he foreign oupu gap does maer for home inflaion precisely because he foreign oupu gap influences domesic marginal cos Ceeris paribus, an increase in he foreign oupu gap will generally raise domesic inflaion by increasing demand for home goods, which drives up he home real wage hile his noe does no srive o build a realisic model, he model of Engel (2011) seems o have some quie implausible channels hrough which exchange raes affec inflaion, arising from is assumpion of complee markes So, we also consider wo simple versions of he model in which financial markes are no complee indeed, one in which rade is balanced 100 BIS Papers No 70
period by period These help o illuminae channels hrough which globalisaion migh affec inflaion in real world economies 1 The Model and he Phillips Curve Equaions The model is from Engel (2011), which in urn is based heavily on Clarida e al (2002) and Benigno (2004) The model assumes wo counries, each inhabied wih a coninuum of households, normalized o a oal of one in each counry Households have uiliy over consumpion of goods and disuiliy from provision of labour services In each counry, here is a coninuum of goods produced, each by a monopolis Households supply labour o firms locaed wihin heir own counry, and ge uiliy from all goods produced in boh counries Each household is a monopolisic supplier of a unique ype of labour o firms wihin is counry e assume a his poin ha here is rade in a complee se of nominallydenominaed coningen claims Monopolisic firms produce oupu using only labour, subjec o echnology shocks Each firm uses labour inpus from every household wihin is counry Nominal wages are flexible, bu nominal prices are sicky and se according o a Calvo pricing mechanism e allow for differen preferences in he wo counries Home agens may pu a higher weigh in uiliy on goods produced in he Home counry Home households pu a weigh of ν /2 on Home goods and 1 ( ν / 2) on Foreign goods (and vice-versa for Foreign households) This is a popular assumpion in he open-economy macroeconomics lieraure, and can be considered as a shor-cu way of modelling openness A less open counry pus less weigh on consumpion of impored goods, and in he limi he economy becomes closed if i impors no goods e will focus on Home consumer price inflaion, which is a weighed average of inflaion in he Home counry of Home-produced goods and impored (Foreign-produced) goods: (1) π = ( ν / 2) π + [1 ( ν / 2)] π H F Engel (2011) considers wo ypes of price-seing behaviour Producer-currency pricing (PCP) enails each firm seing one price for is goods, in is own currency Alernaively, under local-currency pricing (LCP) each firm ses wo prices: one in he Home currency for sale o Home consumers and one in he Foreign currency for sale o Foreign consumers 11 PCP Under PCP, he dynamics of inflaion for Home goods prices are given by: (2) πh = δ( w ph a ) + βε π H + 1 Here, w is he log of he wage in he Home counry, p H is he log of he price of Home goods in Home currency, and a is he log of he marginal and average produc of labour Thus inflaion depends on he real wage, w ph, relaive o he marginal produc of labour, a, and expecaions of fuure inflaion δ is smaller he less frequen is price adjusmen Home currency inflaion of impored goods, π, is equal o he Foreign inflaion rae of hose F F goods, π, plus he change in he exchange rae, e 1, by he law of one price Tha is, e (3) F F e e 1 π = π +, BIS Papers No 70 101
where: (4) F ( w pf a ) E F 1 π = δ + β π +, for Foreign currency inflaion of Foreign goods, wih variables defined analogously o hose in (2) 12 LCP Under LCP, equaion (2) sill deermines he Home consumer price inflaion of Home goods The consumer prices of Foreign goods are se in Home currency by Foreign firms under LCP, and we have: (5) F ( w pf e a ) F 1 π = δ + + βε π + 2 Openness and Inflaion in Complee Markes Model Clearly, Home consumer price inflaion depends on he global economy hrough impored goods inflaion However, global facors also influence he Home real wage, which from equaion (2) deermines Home CPI inflaion of Home-produced goods In all cases, he rae of inflaion ulimaely depends on he excess of he real wage over he marginal produc of labour If all prices are flexible and he economy achieves efficien allocaions, real wages should equal he marginal produc of labour Bu in Keynesian models, prices are sicky and oupu is demand-deermined, which means ha he equilibrium real wage may eiher exceed or fall shor of he marginal produc of labour 21 PCP Under PCP, we have: πh = δ ( σ / D) + φ y + ( σ + φ) y + βε π H + + u (6) ( ) 1 Here, y is equal o he average of he Home and Foreign oupu gaps, ( y + y )/2, while y ( y y )/2 The parameer σ is he inverse of he ineremporal elasiciy of subsiuion, while φ is he inverse of he Frisch elasiciy of labour supply Also, 2 D σν (2 ν ) + ( ν 1) The erm u refers o a cos-push shock, as in Clarida e al, ha arises from ime-varying labour-marke condiions From his equaion, we can see he effec of he foreign oupu gap on inflaion of Homeproduced goods (holding he Home oupu gap and expeced fuure inflaion consan): (7) π / y = δσ (1 (1/ D)) / 2 = δσ ( σ 1) ν (2 ν ) / 2D H In he empirically plausible case of σ > 1, we find ha inflaion of Home-produced goods increases wih a rise in he Foreign oupu gap Inuiively, an increase in Foreign demand raises demand for Home goods, which increases demand for Home labour This pushes up he real wage above he marginal produc of labour leading o inflaionary pressure A well-known resul in Clarida e al (2002) is ha he Foreign oupu gap does no influence inflaion of Home-produced goods, precisely in his model Clarida e al (2002) define oupu gaps in a way ha is useful for heir analysis bu does no correspond o he usual definiion for empirical work Under Engel s (2011) definiion, he Home and Foreign oupu gaps are he differences beween acual and he oupu poenial of each counry when resources are used efficienly in he global economy Under Clarida e al s definiion, he Home poenial 102 BIS Papers No 70
oupu akes he acual level of Foreign oupu as given Hence, an increase in Foreign oupu, perhaps caused by a moneary expansion, lowers Home poenial oupu (The mechanism is ha he increase in Foreign oupu improves Home s erms of rade The increase in Home wealh reduces Home labour supply, hus reducing Home s poenial oupu under his definiion) The key poin is ha no maer how he erm oupu gap is defined, an increase in Foreign demand raises inflaion of Home-produced goods Under Engel s definiion of oupu gap, his is refleced as he effec of he Foreign oupu gap on Home inflaion Under Clarida e al s definiion, he increase in Foreign demand lowers Home poenial oupu, hus raising he Home oupu gap and increasing Home inflaion Economies are more open when ν is close o 1 (and mos closed when ν = 2 ) From equaion (7), we can see ha he effec of he Foreign oupu gap on inflaion of Home goods is maximized when he economies are mos open Home CPI inflaion is also influenced by inflaion of impored goods, πf = πf + e e 1 Of course, hese receive a greaer weigh in Home CPI inflaion he more open he economy e have: π ( / ) ( ) F = δ σ D + φ y + σ + φ y + βε π F + 1 + u (8) ( ) The effec of he Foreign oupu gap on Foreign inflaion is given by (9) π / = δφ [ + σ(1 + (1/ D)) / 2] F y hen σ > 1, he effec of he Foreign oupu gap on Foreign inflaion is smaller he more open he economy, as we would expec However, he rae of inflaion of Foreign goods plays a larger role in deermining Home inflaion when he economy is more open ecall ha Foreign inflaion receives a weigh of 1 ( ν / 2) e find [1 ( ν / 2)]( πf / y ) is maximized he more open he economy, and of course is zero when he economy is closed Combining he effecs of he Foreign oupu gap on inflaion of Home-produced goods and impored goods, and holding he exchange rae consan, we find: (10) π / y = ( ν / 2) π / y + [1 ( ν / 2)] π / y = δ[[1 ( ν / 2)] φ + σ(1 + (1 ν)(1/ D)) / 2] H F The Foreign oupu gap has is maximal impac on Home CPI inflaion when he economy is mos open, 1 ν = Finally, under PCP, exchange rae changes are passed one-for-one ino impor prices These, of course, have a larger role in Home inflaion he more open he economy 22 LCP Under local-currency pricing, we have πh = δ ( σ / D) + φ y + ( σ + φ) y ( D ( ν 1)) / 2D m + + βε π H + + u (11) ( ) ( ) 1 πf δ σ φ σ φ ν β π F + 1 (12) (( / ) ) = D + y + ( + ) y + (( D+ 1) / 2D) m + Ε + u Here, m represens he currency misalignmen he undervaluaion of he domesic currency I is a measure of he raio of Foreign o Home prices of idenical goods: m e + ph ph = e + pf pf Under symmeric Calvo pricing, he price differenial paid by Foreign versus Home consumers is equal for boh Home- and Foreign-produced goods I is apparen from comparison of (11) and (12) o (6) and (8) ha he Foreign oupu gap s influence on Home inflaion is he same under LCP as under PCP BIS Papers No 70 103
Under PCP, a change in he exchange rae, e e 1, is passed direcly ino Home inflaion of impored Foreign goods Bu under LCP, Home consumer prices of Foreign-produced goods are se in he Home currency, so here is no direc effec of he exchange rae change on Home inflaion However, currency misalignmens affec Home inflaion e have: (13) π / m = δ(( σ 1) ν + 1)(2 ν) / 2D H (14) π / m = δ(( σ 1)(2 ν) + 1) ν / 2D F (15) π / m = ( ν /2) π / m + [1 ( ν /2)] π / m = δσν (2 ν )/2D H F No surprisingly, he impac of currency misalignmen on Home CPI inflaion is larges when he counry is mos open ( ν = 1), and he effec is zero when he economy is closed ( ν = 2 ) Bu why do currency misalignmens have an effec on inflaion? Tha is, from equaions (11) and (12), i is apparen ha hese exchange rae effecs work hrough some channel oher han oupu gaps Even when he Home and Foreign oupu gaps are zero, a currency misalignmen influences exchange raes This channel arises because of he influence of asse markes Under he well-known equilibrium condiion when markes are complee, we have: (16) ( 1) σc σc = m + ν s, where s = pf ph = pf ph, so ha m + ( ν 1) s is equal o he real exchange rae Under complee markes, a Home depreciaion ha increases m redisribues resources oward Home consumers This wealh redisribuion reduces he incenive for Home households o work, hus increasing he Home real wage From equaion (2), his increase in he Home real wage leads o an increase in inflaion The same redisribuion will end o lower he Foreign real wage, bu less han one-for-one wih he depreciaion Hence, he Home currency cos of Foreign goods also rises, which from equaion (5) leads o an increase in π F How realisic is his channel? Of course, in he real world, markes are no complee However, even wih a small number of asses raded, he disribuional effecs of complee markes can be replicaed Engel and Masumoo (2009) show how a Home depreciaion can have idenical wealh effecs as in equaion (16) if each counry holds a porfolio of nominal bonds in which hey hold no ne deb, bu are debors in heir own currency and crediors in he oher counry s currency A Home depreciaion hen redisribues wealh o Home consumers This may no be a plausible channel hrough which exchange raes influence inflaion for a variey of reasons I is worhwhile examining how he Phillips curves are affeced when his channel is cu off So we urn nex o models in which rade is coninuously balanced and here is no rade in financial asses Henceforh, we will consider only models wih LCP, since we are primarily concerned here abou he influence of exchange rae misalignmens on inflaion 3 Openness and Inflaion in Balanced Trade Models Under balanced rade and local-currency pricing, we find: πh = δ σν ( 1) + 2 ν+ φ y + ( σ+ φ) y ( D ( ν 1)) / 2 m + + βε π H + + u (17) ( ) ( ) 1 104 BIS Papers No 70
πf δ σν ν φ σ φ ν β π F + 1 (18) ( ( 1) 2 ) = + + y + ( + ) y + ( 1 + D) / 2) m + Ε + u e find ha he influence of he Foreign oupu gap on Home inflaion is slighly differen under his formulaion compared o he complee markes case: (19) (20) π / y = δσ ( 1)(2 ν) / 2 H π / y = δ [( σν + 2 ν )/2 + φ] F (21) π / y = ( ν /2) π / y + [1 ( ν /2)] π / y = δ [(2 ν )( σν + 1 ν )/2+ φ] H F The wealh disribuion is differen under balanced rade han under complee markes, bu he qualiaive conclusions on he influence of he Foreign oupu gap on inflaion is he same: Assumingσ > 1, a higher Foreign oupu gap raises π H, and his effec is larger he more open he economy A higher Foreign oupu gap also increasesπ F, bu his effec is smaller he more open he economy Bu overall, he effec of he Foreign oupu gap on Home CPI inflaion is larger he more open he economy when σ > 1 Noice from equaions (17) and (18) ha currency misalignmens sill influence inflaion, even when oupu gaps are zero Tha is because here is sill a wealh redisribuion effec of an undervalued Home currency, and i works in he same direcion as in he complee markes model Here he effec comes hrough he influence of exchange raes on profis of exporers A Home depreciaion increases he revenue for Home firms ha are selling in he Foreign counry and have priced in Foreign currency, while i reduces he revenues for Foreign firms This wealh redisribuion from Foreign o Home works hrough he same channels as in he complee markes model o influence inflaion e find: (22) π / m = δ(( σ 1) ν + 1)(2 ν) / 2 H (23) π / m = δν ( ( σ 1) ν(2 ν)) / 2 (24) F [ ] π / m = ( ν /2) π / m + [1 ( ν /2)] π / m = δν (2 ν ) ( σ 1)( ν 1) + 1 /2 H F In his formulaion, he effec on wages of a currency misalignmen may be greaer han he misalignmen ha is, a 1% misalignmen may lead o a greaer han 1% increase in Home real produc wages and a greaer han 1% decline in Foreign real produc wages The overall effec is sill a is maximum when he economy is mos open Even wih balanced rade, exchange raes sill influence inflaion raes hrough wealh effecs However, we migh inquire abou he effecs of openness on inflaion if hese wealh effecs were no presen a all Devereux and Engel (2002) consider a global economy in which some goods are sold by disribuors These disribuors purchase goods direcly from exporers, who se he price in he exporer s currency They sell hem o domesic consumers, bu price in he domesic consumer s currency The disribuor is aking on exchange rae risk, because when he exporer s currency appreciaes unexpecedly, he disribuor pays more for he goods bu does no pass along ha increase o he consumer In his symmeric model wih he wo counries of equal size, when exacly half of all expors are sold o disribuors and he oher half are sold direcly o consumers (and priced LCP), exchange rae flucuaions have no wealh effec A home depreciaion, for example, increases he value of sales from Home firms ha expor direcly o he Foreign consumer Bu Home disribuors of impored Foreign goods lose when he Home currency depreciaes hey mus pay more for he impors bu do no pass along ha cos increase o he Home consumers Under balanced rade, he ne wealh effec for he Home counry is zero he gain in wealh by he exporers is balanced off by he loss of wealh by he disribuors In his case, we find: BIS Papers No 70 105
πh = δ σν ( 1) + 2 ν+ φ y + ( σ+ φ) y + βε π H + + u (25) ( ) 1 πf δ σν ν φ σ φ β π F + 1 (26) ( ( 1) 2 ) = + + y + ( + ) y + m + Ε + u Comparing hese Phillips curves o equaions (17) and (18) wih no disribuors, we find ha he effecs of oupu gaps are he same in boh cases, bu he currency misalignmen no longer affecs real produc wages Insead, he only effec of a larger m is o increase he Home currency cos of Foreign oupu, hus puing upward pressure on π F So we find simply: (27) π / m = 0 π / m = δ π / m = δ[1 ( ν / 2)] H F In his case, we can conclude ha openness affecs domesic inflaion in hree ways Firs, when an economy is more open, he Foreign oupu gap has a greaer effec on Home inflaion by pushing up domesic wages and herefore inflaion of Home-produced goods Second, he Foreign oupu gap influences he price of impored goods hile he Foreign oupu gap has a smaller effec on Foreign inflaion he more open he economies, he effec on Home inflaion is noneheless larger because greaer openness implies a larger impor share Finally, currency misalignmens affec inflaion by increasing he Home currency cos of impors, which pushes up inflaion of hose goods Tha effec increases wih openness again simply because impors are a larger share of consumpion 4 The Effecs of Openness on Loss Funcions The Phillips curves can be hough of as he consrains facing policymakers Openness migh also affec he objecives of policymakers ha aim o maximize welfare of households Here we follow Engel (2011) and consider policymaking under cooperaion e examine how openness affecs he weigh policymakers pu on inflaion relaive o oher objecives (oupu gaps and currency misalignmens) In he model of Engel (2011), under PCP, he loss funcion for he policymaker can be expressed as he expeced presen discouned value of Ψ, where 2 2 2 2 (28) Ψ [( σ / D) + φ] ( y ) + ( σ + φ)( y ) + ( ξ /2 δ) (( πh ) + ( πf ) ) Here, ξ is he elasiciy of subsiuion for consumers among differen varieies of goods produced wihin a counry Openness does no influence ξ /2δ The only role ha openness 2 plays in his loss funcion is in he parameer D σν (2 ν ) + ( ν 1) Assumingσ > 1, D is larger he more open he economies are This increased openness reduces he influence of 2 ( y ) in he loss funcion Firs, consider why relaive oupu gaps maer a all Suppose he world oupu gap were zero, bu one counry s oupu gap was posiive and he oher s was negaive One counry is producing excessive oupu, and he oher s is insufficien This producion arrangemen is clearly inefficien, bu in erms of is impac on welfare, he effec is smalles when economies are mos open In he exreme case of complee openness, he inefficien producion srucure does no have an allocaive effec across households in he wo counries Households in each counry have he same consumpion baske, and will consume more of he goods from he counry ha overproduces and fewer from he counry ha underproduces As he economies become less open, he relaive oupu gap causes furher disorions no only o he producion srucure bu o opimal consumpion disribuion High Home oupu and low Foreign oupu, for example, hurs Foreign households more han Home households when here is home bias in consumpion 106 BIS Papers No 70
Hence, from a global perspecive, openness reduces policymakers concerns abou oupu gaps relaive o he weigh pu on inflaion Under LCP, Engel (2011) finds (29) σ 2 2 ν(2 ν) 2 ξ ν 2 2 ν 2 ν 2 2 ν 2 Ψ + φ ( y ) + ( σ + φ)( y ) m ( πh ) ( πf ) ( πf ) ( πh ) D + + + + + 4D 2δ 2 2 2 2 The influence of openness on he radeoff beween oupu gaps and inflaion is he same under LCP as under PCP Now, as Engel (2011) emphasizes, in addiion o oupu gaps and inflaion, policymakers mus also be concerned abou he losses from currency misalignmens Those are maximized when he economies are mos open As Engel (2011) noes, currency misalignmens cause a loss hrough heir effecs on consumpion allocaion hen Home and Foreign oupu gaps are zero, hen aggregae oupu in each economy is a an efficien level Moreover, if all inflaion raes are zero, hen here is no oupu misallocaion wihin each counry Even in his case, currency misalignmens cause misallocaion because he complee markes equilibrium condiion (16) shows ha when m 0, here will be incomplee consumpion risk sharing, so c c In his symmeric model, equal Home and Foreign consumpion is opimal for he global policymaker, so hey would like o drive currency misalignmens o zero hen rade is balanced, under LCP, we find (30) ν(2 ν) D Ψ + + + + + 4 ξ ν 2 2 ν 2 ν 2 2 ν 2 + ( πh ) ( πf ) ( πf ) ( πh ) 2δ + + + 2 2 2 2 2 2 2 2 ( σ 1)( ν 1) φ ( y ) ( σ φ)( y ) m ( σ 1) ν(2 ν)( ν 1) my Alhough he magniudes are somewha differen, he qualiaive role of openness on he radeoffs beween oupu gaps and inflaion, and currency misalignmens and inflaion are similar o he complee markes case As economies become more open, he weigh 2 policymakers pu on ( y ) declines Also, as economies become more open, he weigh pu on 2 m increases, as we would expec Ineresingly, here is anoher erm in he loss funcion ha involves my Noice ha his erm has y = ( y y )/2, which is he average of he acual oupu difference, no he oupu gap difference This is anoher channel hrough which currency misalignmen leads o consumpion misallocaion, in he case when rade is balanced ecall ha under balanced rade, here was a wealh effec from a Home depreciaion, as Home firms gain revenue from foreign sales This ends o benefi Home consumers, and he benefi is larger he greaer is Home oupu relaive o Foreign oupu Tha is because, unless he economies are perfecly open, Home consumers benefi more from an increase in Home oupu han Foreign consumers Bu noe ha when economies are perfecly open, ν = 1, his effec disappears Under complee openness, an increase in Home oupu does no benefi Home consumers under balanced rade So his componen of he loss funcion is zero eiher when economies are compleely closed ν = 2, or compleely open, ν = 1 Finally, in he model wih disribuors, he wealh effecs of currency misalignmens disappear In his case, he loss funcion is simply BIS Papers No 70 107
2 2 2 ξ ν 2 2 ν 2 ν 2 2 ν 2 (31) Ψ ( σ 1)( ν 1) + φ ( y ) + ( σ + φ)( y ) + ( πh ) + ( πf ) + ( πf ) + ( πh ) 2δ 2 2 2 2 This is he same as in he balanced rade model, excep ha currency misalignmens have no welfare effec Conclusions In each of hese models, we could go furher e could deermine a moneary policy for he cenral bank As in many models, we migh se an ad hoc ineres-rae rule, or we migh insead deermine he opimal policy by minimizing he loss subjec o he consrains presened by he Phillips curves In eiher case, wih a moneary policy rule in hand, we can hen ake he Phillips curves, he goods marke equilibrium condiions and he financial marke equilibrium condiions and solve for he endogenous variables e can solve for equilibrium inflaion, and hen perform he comparaive saic exercise of asking how greaer openness affecs seady-sae inflaion e could also see he influence of openness on he dynamic response of inflaion o shocks produciviy shocks, cos-push shocks, and possibly moneary policy shocks The model examined here is no a realisic model, so we canno easily draw real world conclusions abou he effecs of openness on inflaion from his sudy Insead, he objecive here is o sugges a blueprin for analysis of he influence of openness on inflaion e can go beyond asking how openness influences inflaion in equilibrium, which depends boh on he srucure of he economy and he moneary policy rule e can look a he influence of inflaion on he Phillips curve, which shows role of he economic srucure; and, we can see how openness influences he objecives of policymakers, which demonsraes he role of moneary policy Here we have found ha openness maers for inflaion because he foreign oupu gap influences domesic inflaion, and poenially also because exchange raes affec aggregae demand hrough wealh effecs eferences Ball, Laurence 2006 Has Globalizaion Changed Inflaion? Naional Bureau of Economic esearch, working paper no 12687 Borio, Claudio, and Andrew Filardo 2007 Globalisaion and Inflaion: New Cross-Counry Evidence on he Global Deerminans of Domesic Inflaion Bank for Inernaional Selemens, BIS orking Paper no 227 Benigno, Gianluca 2004 eal Exchange ae Persisence and Moneary Policy ules Journal of Moneary Economics 51:3, 473-502 Clarida, ichard; Jordi Gali; and, Mark Gerler 2002 A Simple Framework for Inernaional Moneary Policy Analysis Journal of Moneary Economics 49:5, 879-904 Devereux, Michael B, and Charles Engel 2002 Exchange ae Pass-Through, Exchange ae Volailiy, and Exchange ae Disconnec, Journal of Moneary Economics 49, 913-940 Engel, Charles 2011 Currency Misalignmens and Opimal Moneary Policy: A eexaminaion, American Economic eview 101, 2796-2822 Engel, Charles, and Akio Masumoo 2009 The Inernaional Diversificaion Puzzle when Goods Prices are Sicky: I s eally abou Exchange-ae Hedging, no Equiy Porfolios, American Economic Journal: Macroeconomics 1, 155-188 108 BIS Papers No 70