All together now: Do international factors explain relative price co-movements?

Recent research has found evidence of increasing co-movement in CPI inflation rates across industrialised countries. This paper considers whether this increased international co-movement in inflation rates can be attributed to greater global integration of product markets. To examine this question, we use a data set of 28 matched product category price indices for 14 advanced economies for 1998Q1 - 2008Q2, and decompose the inflation rates into a world factor, country-specific factors, and category-specific factors using a Bayesian dynamic factor model with Gibbs sampling. We find that the category-specific factors account for a large part of the co-movement in the prices of goods which are intensive in internationally traded primary commodities; but this is less evident for other traded goods. We also find that both the world factor and the category-specific factors become more significant in explaining the movement in the relative prices in the second half of our sample.