Global trade, transportation technology, and inflation

Abstract

This paper examines the impact of international trade on inflation using a novel geographic instrument grounded on advancement in air transportation technology. This paper employed a time-varying geographic instrument to address the endogeneity issue and uses a full panel framework with country and time effects. This instrument correctly identifies the causal effects of trade on inflation by considering variation in effective distances between countries over time and revealing that the importance of air transportation trade is growing rapidly compared to sea trade. The empirical results show that there is a significant negative relationship between trade and inflation: a 1 per cent rise in trade volume leads to a decline in inflation by over 0.317 per cent per year between 1960 and 1995. This Study supports Romer's (1993) findings, which suggest a negative relationship between trade openness and inflation, while offering a more comprehensive and contemporary understanding of this dynamic.