RDP 2012-01: Co-movement in Inflation 6. Conclusion

This paper has presented a panel VAR model for the G7 economies that allows for rich interactions between countries and variables while maintaining a parsimonious model structure. Following Canova et al (2007) and Canova and Ciccarelli (2009), observable factors or indicators were obtained from the model, highlighting co-movement between the series in the panel VAR. The model was used as a framework to investigate the issue of global inflation.

While not presenting a structural explanation, the panel VAR was used to evaluate different possible interpretations of the correlation in inflation rates across countries observed in the data. Common shocks to commodity prices, but not to global real activity, were found to be important for driving ‘global inflation’ dynamics. However, there is still statistical evidence of co-movement in G7 inflation rates even after controlling for the possible influence of commodity prices and global activity.

Given the role of the common inflation indicator in explaining inflation in the G7 countries, it was then also investigated whether global inflation has a significant influence on Australian inflation. To do this, a global inflation measure was added to standard single equation models for headline and underlying inflation in Australia. The results again indicate that movements in international inflation contain useful information for explaining domestic inflation, particularly headline inflation.