Trade openness and inflation: The role of real and nominal price rigidities

Anna Watson

Journal of International Money and Finance, 2016, vol. 64, issue C, 137-169

Abstract: The paper revisits the long-standing question of the impact of trade openness on the inflation–output trade-off by accounting for the effects of product market competition on price flexibility. The study develops a New-Keynesian open-economy dynamic stochastic general equilibrium model with non-constant price elasticity of demand and Calvo price setting in which the frequency of price adjustment is endogenously determined. It demonstrates that trade openness has two opposing effects on the sensitivity of inflation to output fluctuations. On the one hand, it raises strategic complementarity in firms' pricing decisions and the degree of real price rigidities, which makes inflation less responsive to changes in real marginal cost. On the other hand, it strengthens firms' incentives to adjust their prices, thereby reducing the degree of nominal price rigidities and increasing the sensitivity of inflation to changes in marginal cost. The study explains the positive relationship between competition and the frequency of price adjustment observed in the data. It also provides new insights into the effects of global economic integration on the Phillips Curve.

Keywords: Trade openness; Inflation; Nominal rigidities; Real rigidities; Phillips Curve (search for similar items in EconPapers)
JEL-codes: E31 E32 F41 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:64:y:2016:i:c:p:137-169

DOI: 10.1016/j.jimonfin.2016.02.002

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