Sources and Variability of Inflation in an Open Economy

This paper presents an empirical analysis of inflation in an open economy. Using Philippine data, the paper first estimates the variance of inflation using a standard ARCH model and shows that periods of high inflation are succeeded by periods of high volatility. Next, the sources of inflation are analyzed using a macroeconomic vector autoregression model. The variance decomposition attempts to determine whether the fiscal view or the BOP view of inflation holds for the Philippines. It is shown that the BOP view holds but this result is not sufficient to say that the former is unimportant in the inflation process.