Globalisation and the Decoupling of Inflation from Domestic Labour Costs

We provide novel systematic cross-country evidence that the link between domestic labour markets and CPI inflation has weakened considerably in advanced economies during recent decades. The central estimate is that the short-run pass-through from domestic labour cost changes to core CPI inflation decreased from 0.25 in the 1980s to just 0.02 in the 2010s, while the long-run pass-through fell from 0.36 to 0.03. We show that the timing of the collapse in the pass-through coincides with a steep increase in import penetration from a group of 10 major manufacturing EMEs around the turn of the millennium - which signals increased competition and market contestability. Besides the extent of trade openness, we show that the intensity of the pass-through also depends in a non-linear way on the average level of inflation