Exploring international differences in inflation dynamics

Standard closed-economy DSGE models have difficulty replicating the persistence of inflation. We use a multicountry dataset to establish some empirical regularities on persistence and volatility of aggregate consumer prices for 135 countries since 1993. We find both persistence and volatility to be low (high) in developed (developing) countries relative to the full sample average. This pattern is also observed in low (high) inflation countries. We then employ a two-country DSGE framework to investigate the extent to which structural open economy features, such as incomplete exchange rate pass-through, the existence of nontraded goods, and international financial market incompleteness, can help in replicating the persistence and volatility of consumer prices. Our simulation results indicate that the model can replicate the degree of inflation persistence seen in the data for both developed and developing countries, but cannot generate the low levels of volatility observed in developed economies.