3. Does Trade-Openness Affect the Role of the Domestic Output-Gap on Inflation? If So, What is the Role of the Global Output-Gap?

Are there changes in the impact of the South African and Chinese output-gaps as trade-openness moves from a low to a high trade-openness regime? Evidence is this chapter shows that the impact of the Chinese output-gap increases as the trade conditions move from a low trade-openness regime to a high trade-openness regime. The Chinese output-gap has a bigger impact on domestic inflation as trade-openness increases. At the same time, the role and impact of the domestic output-gap on domestic inflation diminishes. In addition, we find that the impact of the South African output-gap declines when moving from a low regime to a high trade-openness regime. These results are consistent with prediction of the inflation globalisation hypothesis and the importance of trade-openness in changing the manner in which the foreign output-gap affects the domestic inflation. In addition, the degree of trade-openness affects the rate at which the external output-gaps impact the transmission of import price inflation and the exchange rate changes via changes in the domestic output-gap. The policy implication is that the degree of trade-openness matters for the impact of global output-gaps on domestic inflation irrespective of the exchange rate changes. Structural reforms and policy efforts to rebalance the economy from high dependency on imports should not lose sight of the benefits that accrue from global trade activity. Hence, the consideration of the trade-openness and import penetration regimes plays an important role in guiding policy interventions in the manufacturing sector.