Technical Paper Series

Macroeconomic Analysis and Tax Analysis Divisions

Congressional Budget Office

Washington, DC

THE IMPACT OF GLOBALIZATION

 ON THE 

U.S. BUSINESS CYCLE

Edward N. Gamber

Lafayette College

Juann Hung

Congressional Budget Office

April 1999

1999-6

Technical papers in this series are preliminary and are circulated to stimulate

discussion and critical comment. The views expressed in this paper are those of

the authors(s) and should not be interpreted as those of the Congressional

Budget Office. Reference in publications should be cleared with the authors.

Papers in this series can be obtained by sending an email to

techpapers@cbo.gov.
1

The Impact of Globalization on the U.S. Business Cycle

This paper investigates whether the U.S. has become more globalized and if so

whether that increased globalization has helped hold down inflation and prolong the

current economic expansion. We find that U.S. globalization, which has been rising

significantly over the past four decades, surged beyond its earlier trend in the 1990s.

Import prices exert a greater impact on prices of products in industries faced with

greater import penetration. High foreign excess capacity accounts for much of the

recent decline in U.S. inflation. Finally, the degree of business cycle synchronization

appears to influence the duration of business cycles. Synchronized cycles are shorter

than asynchronized cycles. Our findings suggest that foreign recessions have

enhanced the role of globalization in sustaining the current expansion; however,

globalization alone could have shortened, not lengthened, the current expansion if

it were synchronized with foreign expansions.

1. INTRODUCTION

Has globalization prolonged the U.S. expansion of the 1990s? Two hypotheses have

been proposed for how the rise in globalization may have held down inflation and

therefore deterred the Fed from tightening monetary policy and prolonged the current

U.S. expansion. The first is the so-called “competing-goods effect” hypothesis which

contends that greater competition from foreign producers has limited the ability of

domestic producers to raise prices. The second hypothesis maintains that excess

capacity abroad has helped U.S. manufactures meet the robust domestic demand in

the U.S. without straining domestic resources and pushing up inflationary pressures.

This paper first lays out a general framework that integrates these two

hypotheses, and then investigates each of them empirically. We find evidence in
2

support of both hypotheses. To examine the competing-goods effect hypothesis, we

estimate panel data regressions to find whether import prices have indeed exerted

a greater impact on product prices in industries that are faced with greater import

penetration. The results are affirmative.

We study the second, and more general, hypothesis by making three inquiries.

First, has the rise in globalization coincided with the breakdown of the traditional

Phillips curve’s ability to predict inflation that began in early 1990s? That is, has the

United States become considerably more open in the 1990s than in previous years

when the Phillips curve tracked inflation with reasonable accuracy? Second, has

foreign capacity utilization played an important role, along with traditional

explanatory variables, in predicting inflation? Finally, have U.S. expansions tended

to be longer when foreign economies have larger excess capacity, and shorter when

foreign economies have smaller excess capacity? 

Our empirical evidence suggests that the answers to all three inquires are also

positive. Most striking is the finding that, by including foreign capacity utilization

in the estimation of a Phillips curve equation, almost all of the missing inflation—the

difference between actual inflation and predicted inflation based on the traditional

Phillips curve—since 1994 disappears. 
3

Our findings suggest that the interaction of slack foreign economic conditions

and greater openness to trade may have helped prolong the current U.S. expansion,

but globalization alone has not permanently reduced the threat of recession or

inflation. Indeed, greater globalization may even help shorten expansions or

lengthen recessions when those economic conditions are synchronized with

conditions abroad.

No single researcher has looked at all of the questions posed in this paper but

each question has been investigated separately before. Krugman (1994,1995) and

Irwin (1996) have looked at whether the U.S. has become more globalized over the

past decade. They find that trade with the rest of the world is not a significant or

rapidly growing influence on the U.S. economy. The question of whether prices of

foreign goods influence domestic prices through the competing-goods effect has been

investigated by Swagel (1997). He finds a statistically significant but small impact

in 10 of the 19 industries in his sample. Similarly, Slaughter and Swagel (1997) find

that increased globalization has had only a modest impact on wages in industrialized

economies. Finally, Orr (1994) and Tootel (1998) find very little or no impact of

foreign capacity utilization on domestic inflation.

The rest of the paper is organized as follows. Section 2 discusses how

globalization may affect the length of the U.S. business cycle through capital and

trade-flow effects. Section 3 looks at whether the U.S. has become more globalized,
4

in terms of the volume and diversity of trade as well as the volume of capital flows,

in the 1990s. Section 4 investigates whether the rise in the U.S. integration with the

rest of the world has led to an increase in import prices’ influence on manufacturing

prices through competing-goods effects. Section 6 examines whether, and to what

extent, U.S. inflation is influenced by foreign capacity utilization. Section 6

investigates whether the durations of U.S. business cycles have been affected by the

degree of cyclical synchronization around the globe. Section 7 concludes.

2. HOW DOES GLOBALIZATION AFFECT THE BUSINESS CYCLE?

Numerous academic articles have been written about how foreign growth affects the

strength of domestic economic growth through trade flows. Few papers have

examined how foreign economic conditions may affect the duration of domestic

expansions and contractions as the U.S. becomes increasingly integrated with the rest

of the world. In this section we investigate how globalization may affect the duration

of U.S. business cycles.

Our maintained hypothesis is that most (if not all) of U.S. expansions after

World War II have ended with the Federal Reserve’s tightening of monetary policy

in response to the threat of (or actual) increase in inflation (see Romer and Romer,

1989). An implication of this hypothesis is that expansions that are accompanied by
5

modest inflation are likely to last longer than those accompanied by higher inflation.

Thus, our analysis here focuses on how globalization provides the channels through

which foreign conditions affect domestic inflation.

The impact of globalization on U.S. inflation will depend on the economic

conditions in the U.S. relative to those abroad. For example, if a U.S. expansion is

accompanied by deflationary pressures abroad, globalization is likely to help lengthen

the U.S. expansion (relative to autarky) by dampening inflation. On the other hand,

if the U.S. expansion is synchronized with foreign expansions, then the impact of

increased globalization on the U.S. business cycle will depend on the relative

strength of the two economies. Globalization will shorten a U.S. expansion if foreign

growth is relatively stronger, but lengthen a U.S. expansion if foreign growth is

relatively weaker.

This section will focus on the cases when the U.S. is in the expansion phase of

a business cycle. The cases where the U.S. is in recession can be inferred by

symmetric reasoning. 

Foreign influences on the U.S. inflation rate could operate though trade-flow

and capital-flow channels. To illustrate how these channels operate we consider a

world with two economies: domestic (the United States) and foreign. We further

assume that the exchange rate floats freely to clear currency markets. 
6

The U.S. consumer price index (p) can be thought of as a weighted average of

three components—the dollar price of imported goods (pm), the price of importcompeting goods (Pc

) and the price of other goods and services in the consumption

basket (po

):

p = . pm +  pc

 +  po, (2.1)

where ., ,  represents, respectively, the shares of imported, import-competing, and

other goods and services in the consumption basket. All shares are positive and sum

to one.

We assume that the price of other goods is a positive function of the cost of

capital (i), the unit labor cost (u) , and the price of imports (pm):

po = po[i, pm, u, z], po

1 > 0, po2 > 0, po3 > 0. (2.2)

 The vector z represents other factors that could influence po.

We further assume that the price of import-competing goods is a positive

function of the cost of capital (i), the unit labor cost (u) , the price of imports (pm),

and the profit margin ():

pc = pc[i, pm, u(pm), (pm), x] (2.3)

u’ 0, ’ > 0, po

1 > 0, po2 > 0, po3 > 0, po4 > 0.
1. To see that firms’ strategic mark-up is an inverse function of price elasticity, recall that a monopolistic firm

will aim to maximize profits by producing and selling a target quantity Q*. At Q*, unit price (P) is equal

to marginal cost (MC) plus the profit margin (), and  is equal to -P/, where  is the price elasticity of

demand.

7

The vector x represents other variables that affect pc.

Equations (2.2) and (2.3) embody the assumption that prices are determined by

a mark-up over the long-run marginal cost. The long-run marginal cost is a function

of the cost of capital, unit labor costs, and the cost of imported inputs. An increase

in the cost of capital (i) will raise pc

 and po by increasing the long-run marginal

cost. An increase in either u or pm will raise pc

 and po by raising the variable cost

of output. 

We assume that, given the marginal cost schedule, producers have the pricing

power to adjust the mark-up (or, profit margin) to maximize profits, and that the

pricing behavior of producers in the import-competing industries is affected by the

competitive pressure coming from imports so that  is a positive function of pm.

This assumption is consistent with the standard pricing theory in monopolistic

competition models where an increase in the perceived price elasticity will induce

firms to lower the profit margin (), and vise versa1. An increase in pm thus will

increase the profit margin by lowering the perceived price elasticity for importcompeting goods.
8

We also assume that falling import prices could result in lowering the unit

labor cost of domestic firms by forcing them to enhance productivity, so that u is

a non-negative function of pm. This assumption makes sense since the inevitable

pressure on wage inflation in a tightening labor market, which is a normal byproduct

of a continuing expansion, will give domestic firms a strong incentive to improve

their productivity to prevent profit margins from being completely eroded. 

Now we can proceed to discuss how foreign conditions affect the duration of

the U.S. business cycle. 

2.1 The U.S. and Foreign Are Asynchronized

Suppose the U.S. economy is expanding while the Foreign economy is in a recession.

That is, the U.S. has stronger final demand, higher interest rates, higher inflation,

higher capacity utilization, and stronger currency than the Foreign economy does.

In this case, the increasing trade and capital flows between the Foreign and the U.S.

economies will unambiguously help prolong the U.S. expansion relative to autarky

through several effects.
9

The capital-flows effects

a. The cost-of-capital effect: Foreign capital will flow into the U.S. in search

of higher rates of return. This inflow of capital will help hold down the long-term

interest rate and push up equity prices, thereby lowering the cost of capital. This

decrease in the cost of capital will help spur business investment. The increase in

business investment will expand productive capacity, helping to lower the long-run

marginal cost of production. This will help dampen the pressures on Pc

 and Po to rise

in the midst of continuing strength in demand.

b. The wage-setting effect: U.S. firms will have better bargaining power (than

in autarky) in wage negotiation, since they can choose to move their production

abroad to take advantage of lower wages there. Consequently, wage pressures on

inflation will be more mild than in an autarky. Holding productivity unchanged, this

will lower the unit labor cost relative to what it might have been in autarky. This in

turn will help mitigate the inflationary pressure coming from rising labor costs,

making it easier for the expansion to go on without invoking a monetary policy

tightening.
10

The trade-flows effects 

a. The net-export effect: The dollar will strengthen as the higher U.S. interest

rates increase the demand for dollar-denominated assets. A stronger dollar will lower

U.S. import prices while raising export prices. U.S. goods will become less

competitive internationally, thereby mitigating U.S. growth by reducing the U.S.

trade surplus or by widening the deficit. Meanwhile, a weak Foreign economy will

also reduce foreign demand for U.S. exports through the income effect. The cooling

effect of the net-export drag on the domestic economy, by itself, will help dampen

inflation, making the expansion more sustainable—thus longer—than in autarky.

b. The import-price effect: The lower prices of imports will help hold down

domestic prices directly and indirectly. It is easy to see from equations (2.1) through

(2.3) that 

dp/dpm = . +  (dpc/dpm ) + (dpc/du) (du/dpm)+  (dpc/d) (d/dpm) 

+ (dpo

/dpm) > 0. (2.4)

As import prices fall, U.S. consumer prices will fall directly in proportion to . (the

share of imports in the consumption basket) plus  (dpc/dpm) and  (dpo/dpm).

Since both  (dpc

/dpm) and  (dpo/dpm) are positive, the direct effect of changes in

import prices on U.S. inflation is unambiguously greater than .. This point is worth

emphasizing, since it clearly refutes the view held by many economists that import
2. It is not easy to have a precise measurement of .. The imports/GDP ratio is usually used as a rough proxy

for .. But, mainly because non-consumption final demand as a share of GDP is much larger than it as a

share of imports, that ratio tends to underestimate .. The imports/GDP ratio was around 13% in 1997.

11

prices’ impact on U.S. inflation is limited to reflect the modest size of .2

. Even if the

indirect, or competing-goods, effect is negligible, the direct effect alone is already

greater than .. Changes in import prices will directly affect consumer price inflation

not only because imports are a component of the consumption basket, but also

because imports are used as inputs of other consumption goods and services. 

Moreover, falling import prices can also lower U.S. prices indirectly through

the competing-goods effect. As imports become more price-competitive, U.S. firms

in import-competing industries will have to either enhance their productivity, or

lower their profit margins to stay competitive, or both. Either way, the total

magnitude of the competing-goods effect is captured by the second and third terms

of equation (2.4),  (dpc

/du) (du/dpm)+  (dpc/d) (d/dpm). Since  >0,

(dpc/du)>0, du/dpm  0, (dpc/d)>0, and d/dpm >0, the competing-goods

effect is always positive theoretically. Through the combination of these direct and

indirect effects, a decrease in import prices will unambiguously dampen the

inflationary pressure relative to the case in autarky, thereby helping to prolong the

domestic expansion by deterring the Fed from tightening.
12

2.2 The U.S. and Foreign Are Synchronized

Suppose both the domestic and foreign economies are expanding. Both the U.S. and

Foreign economies have strong final demand, high interest rates, high inflation and

high capacity utilization. In this case, the link with the Foreign economy may help

shorten or prolong the U.S. expansion relative to autarky, depending on the relative

strengths of the two economies and their positions relative to capacity. If the foreign

economy has less capacity utilization than the US, then we have a mitigated case of

the complete asynchronized situation discussed in section 2.1. In this case,

globalization may still help prolong a U.S. expansion, though to a lesser extent than

in a complete asynchronized scenario, relative to autarky. If Foreign has higher

capacity utilization than the U.S., however, globalization will shorten, rather than

prolong, the U.S. expansion through the capital-flow and trade-flow channels.

The capital-flow channel:

a. The cost-of-capital effect: U.S. capital will flow out in search of higher rates

of return. The outflow of capital will help push up the long-term interest rate and

lower equity prices, thereby increasing the cost of capital. A rise in the cost of

capital will squeeze business investment and increase the long-run marginal cost of

domestic output. If demand for consumption goods continues to be strong, this will
13

either result in rising inflation or shrinking corporate profits. If it results in rising

inflation, the Fed may raise the interest rate and end the expansion sooner than in

autarky. If it results in lowering corporate profits, unemployment may rise,

disposable income may fall and the economy may enter a recession sooner than it

would if it were an autarky.

b. The wage-setting effect: Higher foreign wages will undermine U.S. firms’

bargaining power (relative to autarky) in wage negotiation, as foreign firms choose

to invest in the U.S. to take advantage of the relatively lower wages here and push up

wage inflation even further. Consequently, the wage pressure on inflation could be

greater than in autarky. If this leads to higher inflation (again, relative to autarky),

it could induce the Fed to raise interest rates sooner, thereby shortening the

expansion.

The trade-flow channel

a. The net-export effect: Capital outflows will weaken the dollar, making U.S.

goods more competitive. A weaker dollar and a stronger foreign economy will result

in increases in net exports. As the U.S. is already operating near full capacity,

however, the increase in net export demand will only add to the domestic inflationary
14

pressure. The resultant higher inflation could induce the Fed to step on the brakes

sooner, thereby shortening the expansion relative to the autarky case.

b. The import-price effect: A weaker dollar will also increase the dollar price

of imports. Higher import prices will contribute to inflationary pressure in the U.S.

both directly and indirectly as discussed in Section 2.1. The rise in inflationary

pressure could prompt the Fed to tighten, thereby shortening the U.S. expansion

relative to autarky.

3. HOW MUCH MORE GLOBALIZED HAS THE U.S. BECOME?

The preceding discussion suggests that the impact of foreign economic conditions on

the U.S. economy depends on the degree of openness or "globalization" of the U.S.

economy. Many economists, notably Paul Krugman (1994, 1995) claim that the U.S.

economy is still "effectively insulated" from foreign competition, since imports and

exports, respectively, only represent slightly over 10% of U.S. GDP (Figure 1). 

It is misleading, however, to rely exclusively on trade flows as a share of GDP

to gauge the degree to which the U.S. is globalized (or, integrated with the rest of

world). These conventional measures tend to mask greater depth and diversity of

trade that have taken place since the mid 1970s. 
15

For example, goods imports as a share of total goods purchased (by firms and

households) shows a much sharper increase in the depth of U.S. reliance on trade

than suggested by the imports/GDP ratio. Goods imports, which have constituted

less than 10 percent of U.S. goods purchased for several decades since the great

depression, have risen sharply since the mid-1970s and now represent nearly 30

percent of total goods purchased (see Figure 2). The dramatic rise in the ratio of

goods imports/goods purchased suggests that imports have indeed become an

increasingly important component of the domestic household and firm purchases of

goods. The discrepancy between the imports/GDP ratio and the goods import/goods

purchased ratio stems from the fact that services—a mostly non-tradeable

sector—have been a growing component of GDP. 

The U. S. trade with the rest of the world has also increased in breadth, or

diversity. This is most obvious from looking at the rise in the number of industries

that are faced with greater import competition. In 1970, only 27 industries (out of

431 industries at 4-digit SIC level) were faced with import penetration ratios greater

than 20%; by 1994, that number had risen to 151 industries (Table 1).

Measures of U.S. engagement in intra-industry trade also indicates a noticeable

increase in the diversity of U.S. trade with the rest of the world. Figure 3 shows the

evolution of two measures of U.S. engagement in intra-industry trade: the intra-
3. The index of intra-industry trade (IIT) is defined as follows: 

 n n

 IID= 1 - [  |Xi -Mi

| 
 (Xi + Mi ) ]

 i=1 i=1

If industry i is exclusively an export or an import industry, then IID is zero. If the exports and imports in

this industry are equal in size, then |Xi -Mi| = 0, and IID=1. Therefore, IIT takes a value between 0 and

1. A higher IIT indicates a higher degree of intra-industry trade. 

16

industry trade index3

, and the cross-industry correlation between imports and exports.

Both measures indicate that the extent to which the U.S. imports and exports similar

(as defined by the 4-digit SIC codes) goods has increased noticeably since the late

1980s. In particular, the correlation coefficient between imports and exports, which

had averaged about 0.5 over the 1960-80 period, rose sharply since the early 1980s

to nearly 0.9 by 1994. 

The increase in both the depth and breath of U.S. trade has important

implications for the inflation and unemployment trade-offs. As explained in the

previous section, changes in import prices not only have a direct effect on U.S.

consumer prices, but also indirect effects by changing competitive pressures on

domestic producers. The rise in the depth of U.S. globalization implies that import

prices will have a greater direct impact on U.S. prices, while the rise in the breath

implies that import prices will have a greater indirect impact on U.S. prices as more

industries will adjust their prices in response to changes in import prices. 
4. National accounting identity dictates I = Sp

 + Sg + NCI, 

where I is domestic private investment, S is private savings, Sg

 is net government saving (or dissaving if

the government runs a budget deficit), and NCI is net capital inflow. In a closed economy where the only

source of financing for investment is domestic and government saving, NCI equals zero. However, in an

open-economy with capital mobility, NCI can be positive and a source of financing domestic investment.

17

In addition to broader and deeper exposures to trade with foreign countries, the

U.S. has also become more globalized in terms of capital flows across its borders.

Both outward and inward capital flows have soared relative to GDP since 1992

(Figure 4). U.S. private capital outflows, which averaged about 2 percent of GDP

($80 billion) per year during the 1980s, surged to nearly 6 percent of GDP ($500

billion) by 1997. The surge in private capital inflows is even more pronounced.

After averaging roughly 3 percent of GDP ($140 billion) per year during the 1980s,

private capital inflows increased to over 9 percent of GDP ($700 billion ) in 1997.

The removal of barriers to capital flows in many industrial as well as emerging

countries has contributed greatly to the increase in both inflows and outflows of

capital across the U.S. border. As argued in section 2, the increase in international

capital mobility implies that foreign economic conditions will have a greater

influence on the duration of U.S. business cycles through capital-flow channels. If

a U.S. expansion is accompanied by a foreign recession, we will likely see net capital

inflows become a more important source of financing for U.S. investment. Indeed,

Figure 5 shows that, while net capital inflows played no role in financing U.S. private

investment before 1981, it has become a significant source of financing for

investment since then.4
18

4. EVIDENCE OF THE COMPETING-GOODS EFFECT

The preceding section indicates that the U.S. has become increasingly more

globalized since early 1980s, and in particular during the 1990s. As discussed in

section 2, the increasing link with foreign economies means that asymmetric shocks

originating abroad could be transmitted to influence U.S. cyclical adjustments more

quickly, broadly, and deeply through several channels. One channel is through trade

flows. Through trade, changes in import prices not only will affect U.S. price

inflation directly through the U.S. consumption of imports, but also could influence

U.S. inflation indirectly through the competing-goods effect. 

In this section we test the hypothesis that import prices affect prices of domestic

goods through the competing-goods effect. The competing-goods hypothesis posits

that falling import prices will induce domestic firms in import-competing industries

to lower the price of their output to stay competitive. Domestic firms can do so

either by enhancing their productivity or by lowering their profit margins.

Conversely, an increase in import prices will induce profit-maximizing producers in

the import-competing industries to raise the strategic mark-up over marginal cost to

exploit the decrease in the price elasticity of demand for their goods. That is, rising

import prices, by lowering competitive pressures on import-competing goods, will

lead to an increase in the prices of domestic goods. 
5. This specification for the dependent variable assumes that the nominal price of domestic goods responds

to the overall price level and import prices. By dividing the domestic price by the overall price index we

implicitly constrain the response to the overall price index to be one-for-one. 

19

To test this hypothesis, we examine the impact of changes in import prices on

domestic prices for a panel of 3-digit SIC code industries. We do so in three stages.

 We begin by investigating whether domestic price changes are positively related to

import price changes, we estimate the following simple equation:

it = . + it

mp (4.1)

where:

it is the percent change in the relative price of output in industry i at time t; or,

the percent change in pit/pt

, where pit is the price of industry i’s output at

time t, and pt

 is the producer price index at time t

5

.

it

mp is the percent change in the import price in industry i at time t.

According to the competing-goods hypothesis, the greater the foreign

competition faced by a particular industry, the greater the positive impact of import

price changes on domestic price changes in that industry. Therefore, we should

expect the greater is import penetration—one measure of globalization—in an

industry, the greater the impact of import prices on that industry’s price. This is

because in a monopolistically competitive framework, a firm can increase its

competitive edge by increasing its reach to those consumers that prefer the
6. Mann’s finding (1997) that a loss of market share to imports is associated with gains to productivity

growth in the United States also gives support to this view.

20

uniqueness of its differentiated product. In a world that is still not completely

globalized and still encumbered by transaction costs, one uniqueness offered by

domestic firms is of course their geographical dominance over foreign firms. From

this perspective, products of foreign firms that have not yet entered a distribution

network to reach American consumers will not constitute as much of a competitive

threat to domestic firms as those that have.6

To test this hypothesis, we re-estimate equation (4.1) by replacing  with a

function of import penetration (IPR). That is, we substitute , so β δγ it it = + IPR

that (4.1) becomes:

it = . + / it

mp + ( IPRit)itmp (4.2)

where, both / and  should be positive, and IPRit is the import penetration ratio for

industry i (defined as M/[M+S-X], where M is imports, S is shipment, and X is

exports) at time t.

Finally, we estimate a third specification in which we allow the import

penetration ratio to enter equation (4.3) independent of its interaction with it

mp :

it = . + / it

mp + ( IPRit)itmp + 3 IPRit (4.3)
21

In both equations (4.2) and (4.3), we are in essence testing whether it is true that

(1) for each percent decrease in import prices, the competitive pressure faced by a

domestic industry is greater the greater is the import penetration ratio—the ratio of

imports relative to consumption—in that industry, and (2) for each level of import

penetration, the competitive pressure is greater the greater is the fall in import prices.

4.1 The Data

We use industry level data on domestic producer prices, import prices, and import

penetration ratios. Annual data for import prices by 3-digit SIC code industry are

from Robert Feenstra (1996). Data on the domestic producer price index for 3-digit

industries are from the Bureau of Labor Statistics and the import penetration ratio is

constructed from data available from the Bureau of Economic Analysis.

By matching the industries in Feenstra’s data set with the PPI data from BLS

we obtained a set of 44 industries (see Table 2) covering the period 1986 through

1992. After transforming the prices to percent changes we had 6 annual observations

on 44 industries for a total of 264 time-series cross-sectional observations.
22

4.2 Estimation Results

The estimation results of equations (4.1), (4.2) and (4.3) are reported in Table 3.

Each equation was estimated twice. First it was estimated using ordinary least

squares (OLS). Then it was estimated with appropriate correction for serial

correlation, and with 43 industry dummies and 4 time dummies to correct for

industry and time period fixed effects. The results of the OLS regressions are

reported on the top panel of Table 3, the results of corrected regressions are in the

bottom panel of Table 3.

The results from estimating equation (4.1) show a positive and statistically

significant relationship between domestic and import price inflation. The results

from equation (4.2) show that the impact of import prices alone is roughly half the

size of the equation (4.1) estimates. The coefficient on the interaction term, IPR

it

mp, is statistically significant but appears to be small. However, if we note that

equation (4.2) can be regrouped into it = . + (/ + IPRit)it

mp, it is clear that the

responsiveness of domestic prices to a change in import prices should be measured

by / + IPRit, which could be much bigger than indicated by either / or  alone.

Figure 6 shows the estimated impact of changes in import prices on domestic

prices, measured by / + IRPit, for each industry in 1992. These estimates range
7. See Gordon (1982).

23

from a low of 0.07 for the “dairy products” industry, which had an import penetration

ratio of 1.5 in 1992 to a high of 0.81 for the “watches, clocks, watch cases and parts”

industry, which had an import penetration ratio of 76.3 in 1992 (Table 2). The

(simple) average import penetration ratio across all industries and time periods is

22.3 which yields a  coefficient of .29. At 0.29 a 1 percentage point increase

(decrease) in average import price inflation leads to a 0.29 percentage point increase

(decrease) in domestic price inflation.

The results from equation (4.3) show that the import penetration ratio has an

independent negative influence on domestic price inflation.

5. FOREIGN CAPACITY UTILIZATION AND THE MISSING

INFLATION

In his 1982 article, Robert Gordon claimed that the Phillips curve had been

“prematurely buried.”7

 He showed that by adding measures of aggregate supply

shocks, exchange rates and dummy variables for wage and price controls he could

explain the combination of high unemployment and high inflation in the 1970s. He

concluded that earlier Phillips curves were mis-specified, not fundamentally flawed

as had been argued by Lucas and Sargent (1978).
24

Beginning in 1995, Robert Gordon's “correctly specified” Phillips curve has

been over-predicting inflation by a substantial amount. According to standard

Phillips curve estimates, falling unemployment should be accompanied by rising

inflation. The fact that inflation has actually fallen since late 1996 despite the

continuing drop in unemployment therefore presents a “missing inflation” puzzle.

Lown and Rich (1997) find that the puzzle is accounted for by the change in the

response of compensation growth to unemployment but fail to explain the puzzling

change in compensation growth. A report by the CBO (1997) attributes the missing

inflation—the over-prediction of inflation by a standard Phillips curve equation—to

three special, temporary factors: low medical care inflation, rapid deflation in

computer prices and declining import prices. While CBO finds that import prices

play a role in explaining the missing inflation puzzle, Tootel (1998) finds that foreign

capacity utilization, which he uses in lieu of import prices in his Phillips Curve

estimation, cannot account for the missing inflation. 

The preceding discussion in this paper suggests that the standard Phillips curve

could become increasingly mis-specified as the U.S. becomes more globalized.

When the U.S. becomes sufficiently globalized, pressures on U.S. inflation will not

only reflect the degree of excess domestic demand (relative to supply) but also that

of excess foreign demand. Consequently, foreign capacity utilization should play a

role in explaining and forecasting U.S. inflation. Since foreign economic conditions

could affect U.S. inflation not only through the import-price effect, but also through
8. This specification is described in more detail in the Economic and Budget Outlook: Update, The

Congressional Budget Office, August 1994, pp.59-63. The CBO specification is based on the specification

in Gordon (1982).

25

other effects—such as the net-export effect, the cost-of-capital effect, and the wagesetting effect—foreign capacity utilization should be included in U.S. inflation

equations along with import prices and other conventional domestic variables.

 To test this hypothesis, we estimate a standard Phillips curve which is roughly

the specification estimated by Robert Gordon (1982) and an alternative Phillips curve

which includes a measure of foreign capacity utilization. The specifications are as

follows:

(5.1) Alternative Phillips Curve:

π ππ π t α β φ δ θλ φ ε it i i ti t

i

i

i

t i

i

t i

m p

t

fe

i

=+ + + + + + + u − f F t i

= =

−

=

− −

=

∑∑∑ ∑ −

0

3

0

4

1

4

1

1

2 0

(5.2) Standard Phillips Curve8:

π ππ π t i ti t α β φ δ θλ φ ε it i 

i i

t i

m p

t

fe

i

=+ + + + + + u − t i

= =

− −

=

∑∑ ∑ −

0

3

1

4

1

1

2 0

where:

 is the inflation rate measured by either the growth of the GDP price index, the

core consumer price index (CPI), or the employment cost index.

u is the unemployment rate for married males,
9. For both the standard and alternative specifications, the growth rate of relative price of food and energy

is included only in the equations of GDP price inflation, not in the equations of the core-CPI inflation.

26

F is foreign capacity utilization,

mp is the growth rate of (Pm/P), where Pm is import prices and P is either the GDP

price index or the core consumer price index,

fe is the growth rate of (Pf&e/Pex) where Pf&e is the consumer price for food and

energy and Pex is the consumer price excluding food and energy products,

 is the deviation of labor productivity growth from its trend, which is measured

by 32-quarter moving average of past growth in labor productivity.

0 is the residual.

In both the alternative and standard Phillips curves specifications, U.S. price

inflation is a function of the unemployment rate, lagged inflation rates, the growth

rate of relative price of food and energy products, the deviation of labor productivity

growth from its trend, and the growth rate of the relative import price.9

 The

unemployment rate proxies for the demand pressure on prices, while lagged inflation

rates controls for expectations of inflation. All the other variables are intended to

control for supply shocks. The only difference between the alternative and the

standard Phillips curves is that the alternative specification also includes foreign

capacity utilization as explanatory variable.
10. Because of the lag length used in the regression, the degree of freedom is smaller than that suggested by

the sample period of 1971:Q1-1998:Q2. 

11. The sum of lagged inflation coefficients are constrained to sum to1 to ensure inflation stability at the

natural rate of unemployment. 

27

For both equations, we use data from 1971:Q1 through 1998:Q210. The

coefficients on the lagged inflation rate are constrained to sum to one and lie along

a 3rd degree polynomial with a zero end point restriction11. The lag length on foreign

capacity utilization is 10 and was chosen based on the Akaike-Information Criteria.

Shorter lag lengths yielded almost identical results.

5.1 The Data

All domestic data and import prices are either directly from, or constructed from, data

published by the Bureau of Economic Analysis. Pf&e is the personal consumption

expenditure (PCE) index for food and energy. Pex is the PCE index excluding food

and energy. The core consumer price index (CPI) is CPI less food and energy prices.

Foreign capacity utilization is constructed by the Board of Governors of the Federal

Reserve System. The Board of Governors compiles foreign capacity indexes based

on various country compositions and weighting methods. We choose to use the

GDP-weighted foreign capacity utilization of all OECD countries. The results are

similar using the other measures of foreign capacity utilization.
28

5.2 Estimation Results

Table 4 reports the coefficient estimates of equations (5.1) and (5.2). Standard errors

are presented in parentheses below the parameter estimates. Inflation forecasts based

on the alternative versus those based on the standard Phillips curve are presented in

Figures 7 and 8. In both figures, forecasted paths of inflation rates are compared to

their actual values since the beginning of 1994. We compute the forecasts by first

estimating equations (5.1) and (5.2) over the entire sample period, then applying the

coefficient estimates to forecast inflation from 1994:Q1 through 1998:Q2 using the

actual values for all right hand side variables except for the lagged inflation rates

which were replaced by the forecasted values. 

Figures 7 and 8 show that the missing inflation—the gap between the actual

inflation and the forecast based on the standard Phillips curve—has been rising

steadily since the end of 1994, with the rise in the missing inflation being more

steady and more pronounced in core-CPI inflation than in the growth rate of the GDP

price index. Most strikingly, inflation rates of both the CPI and GDP price index fell

despite the decline in the married male unemployment rate since 1995. By 1998:Q2

the inflation rate of actual GDP price index (1.2 percent) was roughly 1.2 percentage

points below the forecasted value of the standard Phillips curve, and the actual CPI

inflation rate (2.2 percent) was 1.9 percentage points below the standard forecast.

Since the standard Phillips curve replicated here does control for changes in
12. Roughly 0.1 to 0.2 percentage points of the decline in the inflation rate can be attributed to recent technical

adjustments to the CPI which partially affect the GDP price index.

29

productivity, food and energy prices, and import prices, the missing inflation cannot

be attributed to these supply-side shocks. This puzzling decline in the inflation rate

occurred over a period of apparent mounting demand side stimulus12 is the mystery

we hope to solve by bringing in foreign capacity utilization as an additional

explanatory variable.

Columns 1 and 3 in Table 4 report the estimation results of the “Standard

Phillips Curve” equations, while columns 2 and 4 report those of the “Alternative

Phillips Curve.” In both the standard and alternative specifications, and for both the

GDP price inflation and the CPI inflation equations, import prices are statistically

significant. This should come as no surprise in view of our discussion in sections 2-3

and our empirical evidence in support of the competing goods effect presented in

section 4. However, since the standard Phillips curve equations replicated here

already include lagged import price inflation, their over-predictions of inflation

suggest that the decline in the U.S. inflation since 1994 is only partly attributable to

the decline in import prices.

 Can foreign capacity utilization help close the inflation gap as we predicted?

The second and fourth columns of Table 4 show that the sum of the coefficients on

the lagged measure of foreign capacity utilization is positive and significant at the 5
30

percent level in both the GDP and CPI inflation regressions. Moreover, as indicated

by the “Alternative Phillips Curve” forecasts in Figures 7 and 8, when we repeat the

forecasting exercise described above, the missing inflation all but disappears. These

results clearly support our view that the current excess capacity in foreign countries

has helped lower U.S. inflation through other effects besides the import-price effects.

Table 5 shows that adding foreign capacity utilization to the conventional wage

inflation (measured by the percent change in the employment cost index for wages

and benefits) also helps improve forecasts of wage inflation. The sum of the

coefficients on the lagged measure of foreign capacity utilization is positive and

significant at the 10 percent level. Figure 9 shows that the forecast of this alternative

wage Phillips curve also outperforms that of the standard wage Phillips curve. A

comparison of Figure 9 versus Figures 7-8 also confirms the findings of recent

research that the wage Phillips curve has been doing a much better job in predicting

wage inflation than the price Phillips curve in predicting price inflation in recent

years. It is worth pointing out that this finding lends further supports to our view

that the increased degree of globalization has affected firms’ mark-up behaviors.

But why doesn’t Tootel (1998) find that foreign capacity utilization has a

significant impact on U.S. inflation? Two factors are likely to be responsible for the

difference between our results and Tootel's. First, our measure of foreign capacity

utilization differs from Tootel’s. We use a Federal Reserve Board's measure of
31

foreign capacity utilization which covers all OECD countries. Tootel constructs his

own measure by estimating Phillips curves for six foreign economies (Canada,

France, Germany, Italy, Japan, and United Kingdom), and applies import weights to

get his average foreign capacity utilization. Second, our specification of the Phillips

curve differs from Tootel’s. We allow for both foreign capacity utilization and

import prices to be included as explanatory variables. Tootel, assuming that foreign

capacity utilization affects U.S. inflation only through its effect on import prices,

allows only foreign capacity utilization to enter his Phillips curve specification.

Foreign capacity utilization thus enters the Phillip curve as a substitute for, not in

addition to, import prices, Thus, our specification is more general and allows for

foreign capacity utilization to affect U.S. inflation through non-import-price effects.

6. FOREIGN ECONOMIC CONDITIONS AND THE DURATION 

OF U.S. EXPANSIONS

The discussion in section 2 and the evidence presented in sections 3-5 suggest that

U.S. expansions will tend to be longer when foreign economies have larger excess

capacity, and shorter when foreign economies are closer to, or above, full capacity

utilization. To see whether this can be corroborated by data, we now examine

macroeconomic conditions in foreign countries during five episodes of U.S.

economic expansions.
32

Based on NBER dating of U.S. business cycles, the United States enjoyed five

episodes of economic expansions since 1962. Table 6 shows that, out of these five

episodes, the three longer expansions (1962-69, 1983-89, and 1992-1998) were

accompanied by negative GDP-gaps in foreign countries, while the two shorter

expansions (1971-73, 1976-79) were accompanied by positive foreign GDP gaps.

The average foreign GDP gap is -0.75% during the three longer expansions, and

0.82% during the two shorter expansions.

Unfortunately, Table 6 has an obvious shortcoming: only Germany and Italy

have GDP gap data available during 1962-69. We do not know the extent to which

these two countries’ economic conditions are representative of the rest of the major

foreign countries in this period. It is quite possible that the ten major foreign

countries as whole had a positive, rather than negative, GDP gap during this period.

Such a view would seem compelling in light of the fact that all ten countries were

growing quite briskly during this period (Table 7). On the other hand, however, the

high growth rates of major foreign countries during this period could simply be the

result of these countries’ continuing to catch up after the devastation of WWII.

Given the mass destruction of the war, high growth rates during the 1962-69 period

could very well have been accompanied by negative GDP gaps. Table 8 suggests this

may indeed have been the case: foreign inflation during the 1962-69 high growth

period was actually quite modest at 3.6 percent per year. Indeed, the story presented

by Table 8 is consistent with that presented by Table 6: U.S. expansions tend to be
33

longer when foreign inflation is mild (i.e., when foreign countries operate sufficiently

below its full capacity), and shorter when foreign inflation is high (i.e., when foreign

countries operates near or above full capacity). 

The broad-stroke picture presented by Tables 6 and 8 lend support to the natural

inferences of our open-economy Phillips curve regression results: increases

(decreases) in foreign capacity utilization will add to (lower) U.S. inflationary

pressures. When U.S. expansions occur amid foreign recessions, these expansions

are more likely to be accompanied by lower (than otherwise) inflation. As the Fed

is less likely to raise the interest rate to end expansions that are attended by modest

inflation, these expansions will then tend to last longer than those synchronized with

foreign expansions. 

7. CONCLUSION

This paper shows that the United States has become substantially more integrated

with the rest of the world since the late 1980s. We find that the sharp rise in

globalization of the United States makes foreign conditions an important variable to

be included in explaining the magnitude and duration of U.S. inflations and U.S.

business cycles. However, our findings caution against the view that globalization

per se has ushered in a new age in which the United States will never again be
34

plagued by inflation or recession. Globalization makes it possible for excess foreign

capacity to help dampen U.S. inflationary pressure in the midst of a strong recovery,

thereby prolonging the recovery. However, if foreign condition were different,

globalization alone is unlikely to have done the job of holding down U.S. inflation

in this recovery. In fact, globalization alone could have even shortened, not

lengthened, the current expansion if it were synchronized with foreign expansions.
35

REFERENCES

Grubel, Herbert and P.J. Lloyd, Intra-Industry Trade: The Theory and Measurement

of International Trade in Differentiated products (New York: Halstead Press, 1975.)

Gordon, Robert J. "Inflation, Flexible Exchange Rates, and the Natural Rate of

Unemployment," in Workers, Jobs and Inflation edited by Martin and Baily.

Washington DC: Brookings Institute, 1982, pp.89-152.

Irwin, Douglas, "The United States in a New Global Economy? A Century's

Perspective," American Economic Review Papers and Proceedings, May 1996, pp.

41 - 46.

Lucas, Robert E. and Thomas J. Sargent, "After Keynesian Macroeconomics," in

Federal Reserve Bank of Boston, After the Phillips Curve: Persistence of High

Inflation and High Unemployment, Conference Series No. 19, 1978, pp. 49 - 72

Krugman, Paul, "Past and Prospective Causes of High Unemployment," Economic

Review, Federal Reserve Bank of Kansas City, Fourth Quarter 1994, pp. 23-43.

____________, "Growing World Trade: Causes and Consequences," Brookings

Papers on Economic Activity, 1995(I), pp. 327 - 377.

Knetter, Michael M. "Did the Strong Dollar Increase Competition in U.S. Product

Markets?" The Review of Economics and Statistics, 1994, pp. 192- 195.

Lown, Cara S. and Robert W. Rich, "Is there and Inflation Puzzle?" Economic Policy

Review, Federal Reserve Bank of New York, December 1997, pp. 51 - 67.

Mann, Catherine, “Globalization and Productivity in the United States and

Germany,” International Finance Discussion Papers No. 595, Board of Governors of

the Federal Reserve System, November 1997.

Orr, James A. “ Has Excess Capacity Abroad Reduced U.S. Inflationary Pressures?”

FRBNY Quarterly Review, Summer-Fall 1994, pp. 101-06.

Romer, Christina and David Romer. "Does Monetary Policy Matter? A New

Test In The Spirit of Friedman and Schwartz," in NBER Macroeconomics Annual

1989, edited by Olivier J. Blanchard and Stanley Fisher. Cambridge Mass: The MIT

Press, 1989, pp.121 - 70.
36

Slaughter, Matthew J. and Phillip Swagel, "The Effect of Globalization on Wages in

Advanced Economies," International Monetary Fund working paper, April 1997.

Swagel, Phillip, "Import Prices and the Competing Goods Effect," International

Monetary Fund working paper, August 1997.

Tootel, Geoffrey M. B., " Globalization and Inflation," New England Economic

Review, Federal Reserve Bank of Boston, July/August 1998, pp. 21 - 33.
37

Table 1. The Number of Industries Faced with Import Competition over Time 

(Total of 431 4-digit SIC Industries)

Year

1958 1970 1980 1990 1994

 Import Penetration (IP) in %

 IP = 0 17 6 1 3 4 

 0 < IP  10 381 356 301 184 166 

10 < IP  20 19 42 75 119 110 

20 < IP  30 9 16 24 56 61 

30 < IP  40 2 4 14 25 31 

40 < IP  50 1 3 9 18 26 

50 < IP  60 2 4 5 12 11 

60 < IP  70 0 0 0 7 9 

70 < IP  80 0 0 2 2 6 

80 < IP  90 0 0 0 4 4 

90 < IP  100 0 0 0 1 3 

Source: Import and Export data are from Robert C. Feenstra (www.nber.org/~feenstra/),

Shipments data are from Annual Survey of Manufacturers, by the Census Bureau. 

Note: IPi=Mi/(Si-Xi+Mi), where Mi is imports, Si is shipments, Xi is exports, in industry i.
38

Table 2. Shipment Share and Import Penetration of Industries Used in Testing the

Competing-Goods Effect (%)

SIC # Industry

Average Share

of Shipment 

1987-92

Import

Penetration

1987

Import

Penetration

 1992

201 Meat Products 7.4 4.2 3.5 

202 Dairy Products 4.2 1.6 1.5 

203 Preserved Fruits & Vegetables 3.8 5.5 5.8 

206 Sugar & Confectionery Products 1.8 8.0 8.3 

207 Fats & Oils 1.6 4.9 7.0 

208 Beverages 4.4 7.3 6.6 

209 Miscellaneous Food & Kindred Products 2.7 5.6 6.1 

221 Broad woven Fabric Mills, Cotton 0.5 16.9 16.5 

222 Broad woven Fabric Mills, Manmade Fiber & Silk 0.7 9.3 11.9 

229 Miscellaneous Textile Goods 0.6 12.2 13.6 

231 Mens' & Boys' Suits & Coats 0.2 28.5 26.5 

232 Mens' & Boys' Furnishings 1.3 24.8 31.7 

238 Miscellaneous Apparel & Accessories 0.2 41.6 55.4 

242 Sawmills & Planing Mills 1.7 17.7 16.2 

243 Millwork, Plywood & Structural Members 2.0 7.5 8.2 

259 Miscellaneous Furniture & Fixtures 0.4 11.0 12.3 

261 Pulp Mills 0.5 51.5 50.0 

262 Paper Mills 2.8 17.6 19.8 

281 Industrial Inorganic Chemicals 2.1 15.4 18.7 

289 Miscellaneous Chemical Products 1.6 5.6 6.3 

301 Tires & Inner Tubes 1.0 19.5 20.6 

314 Footwear, Except Rubber 0.4 65.0 67.1 

317 Handbags & Personal Leather Goods 0.1 56.8 60.6 

326 Pottery & Related Products 0.2 44.4 44.9 

331 Blast Furnace & Basic Steel Products 5.1 16.6 15.5 

333 Primary Nonferrous Metals 1.2 37.5 35.7 

335 Nonferrous Rolling & Drawing 3.2 7.6 10.3 

345 Screw Machine Products, Bolts, etc 0.7 12.4 13.5 

353 Construction & Related Machinery 2.4 20.1 20.9 

355 Special Industry Machinery 1.8 24.6 25.2 

362 Electrical Industrial Apparatus 1.6 15.6 21.2 

363 Household Appliances 1.5 14.2 17.0 

364 Electric Lighting & Wiring Equipment 1.6 9.6 17.4 

365 Household Audio & Video Equipment 0.8 64.9 71.1 

366 Communications Equipment 6.5 9.7 12.6 

367 Components & Accessories 5.4 27.2 32.4 

369 Miscellaneous Electrical Equipment & Supplies 1.9 20.4 27.2 

371 Motor Vehicles & Equipment 18.7 29.4 27.8 

382 Measuring & Controlling Devices 1.8 15.4 20.0 

386 Photographic Equipment & Supplies 1.8 20.3 23.4 

387 Watches, Clocks, Watch cases & Parts 0.1 59.3 76.3 

391 Jewelry, Silverware & Plated Ware 0.5 56.5 63.2 

394 Toys & Sporting Goods 0.9 43.4 50.4 

396 Costume Jewelry & Notions 0.2 32.2 36.4 

Source: Import and Export data are from Robert C. Feenstra (www.nber.org/~feenstra/), Shipments data are from Annual 

Survey of Manufacturers, by the Census Bureau.

Note: Shipment share is shipment of an individual industry relative to total shipment of all 44 listed industries.
39

Table 3. Estimations of Competing-Goods Effects

1. OLS Results

Coefficient Estimates on 

Equation mp mp x IPR IPR R2

(4.1) 0.36** 0.30

(0.03)

(4.2) 0.16** 0.01** 0.40

(0.05) (0.002)

(4.3) 0.015** 0.01** -0.03 0.40

(0.05) (0.002) (0.03)

2. Fixed Effects Results Corrected for Serial Correlation

Coefficient Estimates on 

Equation mp mp x IPR IPR R2

(4.1) 0.23** 0.44

(0.02)

(4.2) 0.07* 0.01** 0.58

(0.03) (0.001)

(4.3) 0.05A 0.01** -0.03** 0.60

(0.03) (0.001) (0.01)

Variables:

Dependent variable: inflation in individual industry’s price relative to the producer price index.

Explanatory variable: mp is inflation in the import price, IPR is the import penetration ratio. 

Notes:

Standard errors are in parentheses below the parameter estimates.

A indicates significant at the .10 level.

* indicates significant at the 0.05 level.

** indicates significant at the 0.01 level.
40

Table 4. Estimations of Price Phillips Curves: Standard vs Alternative

Sums of coefficients on: Inflation in GDP Price Index Inflation in Stripped Core CPI

Standard Alternative Standard Alternative

u -0.31* -0.47** -0.47** -0.41*

(0.11) (0.17) (0.20) (0.21)

mp 0.11** 0.12** 0.09† 0.06

(0.03) (0.03) (0.05) (0.05)

fe 0.03 0.04†

(0.02) (0.02)

 -0.02 -0.01 -0.02 -0.03

(0.03) (0.03) (0.06) (0.05)

Foreign capacity 0.27* 0.34*

Utilization (0.12) (0.15)

Adjusted R2 0.92 0.92 0.80 0.81

Variables:

u is the unemployment rate for married males,

mp is the growth rate of (Pm/P),where Pm is import prices and P is either the GDP deflator or the core consumer price index,

fe

is the growth rate of (Pf&e/Pex) where Pf&e is the consumer price for good and energy and Pex is the consumer price excluding

food and energy products,

 is the deviation of labor productivity growth from its trend.

Notes:

The sum of lagged inflation is not presented because it is constrained to equal 1.

Standard errors are in parentheses below the parameter estimates.

† indicates significant at the .10 level 

* indicates significant at the .05 level

** indicates significant at the .01 level
41

Table 5. Estimations of Wage Phillips Curves: Standard vs Alternative

Inflation in ECI Wage

Sums of coefficients on: Standard Alternative

u -0.19 -1.9*

(0.31) (0.9)

imp 0.08† 0.07

(0.05) (0.06)

fe 0.04* 0.05*

(0.02) (0.02)

 0.001 0.03

(0.02) (0.05)

Foreign capacity _____ 0.44†

Utilization (0.23)

adjusted R2 0.46 0.58

Variables:

1. Wage is measured by Employment Cost Index.

2. See Table 4 for construction and definitions of variables.

Notes:

The sum of lagged inflation is not presented because it is constrained to equal 1. Standard errors are in parentheses below the

parameter estimates.

† indicates significant at the .10 level.

* indicates significant at the .05 level.

** indicates significant at the .01 level.
42

Table 6. GDP Gaps in Major Industrial Countries during Periods of US Expansions (percent)

Period I Period II Period III Period IV Period V

1962-69 1971-73 1976-79 1983-89 1992-98c

United States 0.48a 1.10 1.72 0.00 -0.05 

United Kingdom 1.69 1.69 -1.18 

Belgium 0.79 -0.96 -1.99 

France 1.45 0.79 -1.25 -2.10 

Germany -0.64b 1.43 1.23 -1.59 -0.56 

Italy -0.80b 0.27 -0.69 -1.71 

Netherlands 1.25 -0.22 -0.06 

Switzerland -3.43 -0.40 -3.17 

Canada 0.25 1.66 -0.08 -2.25 

Japan 1.39 -0.47 -1.12 -1.18 

Australia 1.72 0.69 -1.03 -1.29 

ROW (Import weight) -0.11b 0.82 0.83 -0.64 -1.59 

Source: OECD Main Economic Indicators and authors’ calculations.

Notes: 1) US Expansions are based on NBER breakdown.

2) GDP Gap = (Actual GDP - Potential GDP)*100 / Potential GDP.

a. Data start in 1964.

b. Data start in 1963.

c. 1998 data are based on forecasts.
43

Table 7. US and Foreign GDP Growth Rates during Periods of US Expansions (percent)

Period I Period II Period III Period IV Period VI

1962-69 1971-73 1976-79 1983-89 1992-98a

United States 4.9 4.9 4.6 4.0 2.8 

Australia 5.9 4.7 3.2 4.0 3.6

Belgium 4.8 5.0 2.6 4.7 1.6

Canada 5.7 6.4 4.6 4.2 2.5

United Kingdom 3.0 4.1 2.4 3.6 2.3 

France 6.0 4.9 3.5 2.5 1.7

Germany 4.4 4.0 3.8 2.5 1.7

Italy 5.5 3.8 4.8 2.8 1.3

Japan 9.9 6.9 4.8 4.1 1.0

Netherlands 6.0 4.1 3.2 2.7 2.6 

Switzerland 4.0 3.6 1.2 2.6 0.4 

ROW (import weighted) 6.0 5.7 4.2 3.8 1.8 

Sources: National Account Statistics: Main Aggregates and Detailed Tables (United Nations); Main Economic Indicators (OECD);

International Financial Statistics (IMF).

Note: a. 1998 data are based on forecasts.
44

Table 8. US and Foreign Inflation Rates during Periods of US Expansions

(percent)

period I period II period III period IV period VI

1962-69 1971-73 1976-79 1983-89 1992-98a

United States 2.6 5.0 7.0 3.6 2.4 

Australia 7.1 10.7 7.6 1.9 

Belgium 3.2 5.6 6.3 3.7 2.0 

Canada 2.9 5.1 8.4 4.5 1.5 

United Kingdom 3.9 8.6 13.4 4.7 2.9 

France 4.1 6.3 9.7 5.0 1.7 

Germany 2.5 5.9 3.7 1.7 2.6 

Italy 3.9 7.1 16.0 8.1 3.9 

Japan 5.7 7.8 6.7 1.7 0.9 

Netherlands 4.7 7.8 5.8 1.4 2.4 

Switzerland 3.5 7.3 1.9 2.4 1.8 

ROW (import weighted) 3.6 6.4 8.0 3.4 1.6 

Source: International Financial Statistics (IMF).

Note: a. 1998 data are based on forecasts.
45

Figure 1: Imports and Exports as a Share of GDP

SOURCE: Survey of Current Business by the Bureau of Economic Analysis.

Figure 2: Goods Imports Relative to Final Demand for Goods

SOURCE: Survey of Current Business by the Bureau of Economic Analysis.
46

Figure 3: Degree of Intra-Industry Trade

SOURCE: Import and Export data is from Robert C. Feenstra (www.nber.org/~feenstra/).

NOTE: Data for 3-digit SIC industries are used. See the text for Intra-Industry Index formula.

Figure 4: Capital Flows as a Share of GDP

SOURCE: Survey of Current Business by the Department of Commerce Bureau of Economic Analysis. NOTE: Capital Flows include portfolio and direct investment flows, but exclude unilateral transfers. 
47

Figure 5: Net Capital Inflow Relative to Private Investment

SOURCE: Survey of Current Business by the Department of Commerce Bureau of Economic Analysis.

NOTE: Capital Flows include portfolio and direct investment flows, but exclude unilateral transfers. 

Figure 6: Domestic Price Responses 

by Industry for 1992

The response of domestic price inflation is it from equation (4.1), where it = / +  IPRit. This figure shows the

variation in it across industries (i = 1 through 44) for t = 1992. The highest response (0.81) is for "watches, clocks,

watch cases and parts," SIC code 387, which had an import penetration ratio of 76% in 1992. The lowest response

(0.07) is for "dairy products," SIC code 202 which had an import penetration ratio of 1.5% in 1992.
48

Figure 7: Inflation Forecasts

year-over-year; quarterly GDP deflator

Figure 8: Inflation Forecasts

year-over-year; quarterly core CPI
49

Figure 9: Wage Inflation Forecasts

year-over-year; quarterly ECI wages