Modeling Inflation In OECD Countries

Inflation has long been a popular topic in the field of macroeconomics. Inflationnot only affects a country’s economic performance, but also affect people’s lives at alllevels. Early in20thcentury, due to the lack of trade and effective capital exportingchannels, inflation only occurs inside the country. Factors affecting inflation are alsolimited to the domestic macroeconomic indicators. However, while the globalizationcan benefit countries, it will also lead to inflation transmission around the world. Thestudy in this area not only established a theoretical system of the internationaltransmission of inflation based on the combination of microeconomic andmacroeconomic theory, but also revealed the main inflation transmission channelsbetween the nations—the price mechanism, the monetary mechanism and thesupply-demand mechanism. The results of these studies furthered the understandingof inflation today, and provided useful references for the government to formulatepolicies.Compare to the existing research on the relationship between the internal factorsand inflation, research on how external factors affect inflation not only started late,but also limited to the trade-related factors. Unlike previous studies, our research willtry to explore the inflation transmission across OECD in two aspects—the role ofdiffusion across countries and exchange rate pass-through, thus provides a newperspective for related research.First, we will systematically arrange the existing research results, describe thecharacteristics of international inflation transmission at different times, and make adetailed analysis of the main transmission mechanism. In order to investigate theeffects of inflation diffusion, we will apply the dynamic panel spatial autoregressivemodel and the local projection method which has been used in Brady (2009). Thetheoretical model is widely used in the studies of exchange rate pass-though (ERPT);in the empirical analysis, we will introduce a spatial factor in order to study the effects of both the inflation diffusion and the ERPT. The empirical result shows that, amongOECD countries, inflation has a strong regional diffusion effect, while the role of theERPT is relatively small. The results tells us that in order to effectively control theinflation in OECD, governments and central banks should work together and takeboth the economic and geographical situation into account.