How local is the local inflation factor? Evidence from emerging European countries

Abstract

We consider whether inflation is a ‘global phenomenon’ for European emerging market economies, as has been claimed for advanced or high-income countries. We find that a global inflation factor accounts for more than half of the variance in the national inflation rates, and show that forecasting models of national headline inflation rates that include global inflation factors generally produce more accurate path forecasts than Phillips curve-type models and models with local inflation factors. Our results are qualitatively unaffected by allowing for sparsity and non-linearity in the factor forecasting models. We also provide some insight as to why global factors are an important determinant of domestic inflation, by considering the country-level characteristics that tend to increase the importance of global factors for domestic inflation.