Globalization has drastically altered the landscape of production, connecting economies and industries in unprecedented ways. With the increasing reliance on imported inputs in production processes, the dynamics of inflation in the UK have undergone significant shifts. The COVID-19 crisis further emphasized the impact of global value chains on inflation dynamics. In a recent study, we delved into the influence of imported intermediate goods on the UK Phillips curve, revealing intriguing insights.
The Phillips curve and globalization
The Phillips curve, a fundamental concept in economic theory, illustrates the relationship between inflation and economic activity. Changes in this relationship can have profound implications for monetary policy. Globalization has emerged as a key factor shaping the Phillips curve, influencing inflation through various channels such as competition, trade in final goods, and crucially, trade in intermediate goods. In today’s trade environment dominated by global value chains, the focus on trade in inputs becomes paramount.
UK’s integration into GVCs
Over the years, the UK has become increasingly integrated into global value chains, particularly noticeable in the manufacturing sector. The rise in imported intermediates from emerging market economies (EMEs) has significantly impacted the composition of inputs in the UK economy. This integration with EMEs begs the question: How has it affected the UK’s Phillips curve?
Exploring the link between GVCs and inflation
Analyzing sectoral data, we investigated the interaction between sectoral dependence on imported intermediate goods and the sectoral output gap to understand how global value chains, especially integration with EMEs, influence the inflation-output gap relationship. Our findings revealed that sectors with higher reliance on imported inputs from EMEs exhibit flatter Phillips curves. This flattening effect is not observed for imported inputs from advanced economies.
The role of China
Further analysis unveiled the specific impact of imported intermediate goods from China, indicating significant roles played by both China and other EMEs. These results underscore the nuanced effects of GVC integration on inflation dynamics.
Conclusions
The increasing integration with EMEs has dampened the sensitivity of inflation to changes in the output gap, flattening the Phillips curve. However, as trade fragmentation continues to evolve, the future trajectory of the Phillips curve remains uncertain. The extent to which firms adapt to changing trade dynamics will shape the responsiveness of inflation to domestic economic conditions.
In conclusion, the interplay between global value chains and inflation in the UK showcases the complex relationship between imported inputs and price dynamics. As the global economic landscape continues to evolve, understanding these dynamics becomes crucial for effective policy-making.
