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Openness and inflation nexus: The case of European post-transition countries

This study explores a unidirectional, negative effect of trade openness on inflation. In the context of globalization of the world economy the aforementioned linked becomes an important tool in examination of national economic policies. Within the framework of post-transition countries that are increasing their trade openness, its significance is exacerbated. Former socialist economies, that had firstly experienced a transition from planned to market economy, and then accessed into the European union, are also continuously increasing their trade openness with European union member states and the rest of the world. Implications of the aforementioned link for this economic area under the umbrella of the European union arise as these European union member states experience another transition and supersede its monetary policy sovereignty to European institutions, where monetary mechanisms for control of inflation and, consequently, unemployment are situated. Hence, the results of this study contribute to the on-going debate on the topic under consideration and improve understanding of inflation dynamics in the sample of socialist post-transition countries since inflation dynamics yield important implications for expected returns of investors and policy makers. This paper employs dynamic panel data approach with generalized method of moments as the estimator to empirically evaluate trade openness and inflation nexus within six European post- transition countries, namely Croatia, Czechia, Romania, Slovakia and Slovenia. While allowing endogeneity of considered variables and controlling effects from unemployment the estimates on annual panel data sample from 2000 up to 2019 suggest negative and statistically significant effects from trade openness to unemployment. Obtained estimates further suggest statistically significant and negative effects from unemployment to inflation. An increase in trade openness decreases unemployment rates while an increase in unemployment rates decreases inflation rates. Therefore, an increase in trade openness eventually leads to increases of inflation rates but no direct effects from trade openness to inflation rates was confirmed as assumed by Romer’s hypothesis. However, empirical results clearly pointed out existence of an effect from trade openness to inflation rates with mediating role of unemployment rates.

Trade openness ; unemployment ; inflation ; dynamic panel data

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