Global slack and open economy Phillips curves - A province-level view from China

- We use subnational data from China to test the “global slack hypothesis.”
- Inflation is more responsive to economy-wide than province-level measures of slack.
- The results support the “global slack hypothesis.”
- The results emphasise the importance of cross-border factors for inflation dynamics.

The “global slack hypothesis” implies that greater integration of the world economy, i.e. globalisation, should have made inflation more responsive to global than domestic economic slack. Many previous studies have accordingly estimated national inflation equations with measures of global output gaps. We use three and a half decades of subnational data from China's provinces to test the global slack hypothesis. Using tests for non-nested regressions, for many provinces we can reject a Phillips curve with a province-level measure of economic slack against a model with China's national output gap, which is consistent with the hypothesis. We also show that the real exchange rate matters for inflation dynamics in many Chinese provinces, in particular those most open to international trade. In addition to supporting the global slack hypothesis, our results emphasise the importance of cross-border factors for China's inflation developments.