Financial vs. trade openness: Where openness matters for CPI inflation and where it doesn’t

This paper identifies a distinct financial channel through which openness affects inflation in a simple model of a bank and a goods-producing firm. Greater financial openness leads to lower inflation if it is cheaper for the bank to borrow abroad than at home. This hypothesis is tested on cross-section data in a sample of 75 countries over the 1973–2016 period. While there is no robust evidence for lower CPI inflation in financially more open economies in all the countries studied, we do find such an inverse link in a subsample comprising OECD countries only. By contrast, the more common measure of openness, trade openness, matters only in non-OECD countries where greater trade openness is negatively related to CPI inflation.