Structural Breaks in International Inflation Linkages for OECD Countries

This paper studies the link between domestic inflation for 19 OECD countries and a corresponding country-specific global inflation series. This is achieved through an iterative methodology, which iterates between coefficient and variance tests, while taking account of outliers. This procedure is applied to both univariate and bivariate inflation models that relate domestic and global inflation, with the latter is calculated as a trade-weighted average of inflation in a country's trading partners. The empirical analysis uses monthly consumer price inflation over 1970 to 2010 and the following key results emerge. First, the univariate analysis yields breaks in the conditional mean that are broadly consistent with the existing literature. Second, we document clusters of variance breaks occurring around the mid 1970s, early 1980s and early 1990s, casting doubt on the claim in the literature that changes of the in inflation has been mainly in the mean. Third, bivariate models show a positive and strengthening contemporaneous relationship between domestic and country specific global inflation. Although the dates and extent of change vary over countries, our results imply increased co-movements of inflation, particularly during the 1980s and 1990s. Fourth, we demonstrate that the above results crucially depend on an appropriate treatment of outliers.