This study analyzes global inflation synchronization and examines the policy implications. Unlike past studies that assume there is only one factor behind global inflation, this study shows that about 63% of the inflation in major economies can be explained by three principal components―the first is closely related to the OECD average inflation while the second and third encompass data on China’s inflation. The OECD average inflation, which has been identified as a key factor of global inflation by preceding studies, was explained through the OECD money supply growth rate and trade (volume) growth rate to GDP.

In-sample and out-of-sample forecasting found that the principal components of global inflation play a significant role in explaining and projecting domestic inflation in the short-term. However, they play a limited role in the mid-term and rather, domestic macroeconomic variables are far more accurate. Accordingly, the recently forecasted global economic stagnation and ensuing concerns over low inflation are expected to have a limited impact on Korea’s inflation. Thus, it is recommended that the Bank of Korea, whose missions is to maintain stable domestic inflation, should focus more on domestic economic conditions than on global inflation when implementing monetary policy. That is not to say that the issue of global inflation should be ignored. In fact, the recommendation implies that domestic macroeconomic variables must be carefully considered as many global factors are already reflected in the variables. In addition, when projecting domestic inflation for the short-term, China’s inflation may become a good indicator.

Preface
Executive Summary

Chapter 1 Introduction

Chapter 2 Global Inflation Synchronization

Chapter 3 Principal Component Analysis (PCA)
　Section 1 Principal Component Analysis of Inflation in Major Economies
　Section 2 Determinants of Global Inflation Principal Components

Chapter 4 Forecasting Domestic Inflation Using LASSO
　Section 1 Statistical Selection of Macroeconomic Variables Using Least Absolute Shrinkage and Selection Operator (LASSO)
　Section 2 Short-Term Impact of Global Inflation Principal Components
　Section 3 Medium-Term Impact of Global Inflation Principal Components

Chapter 5 Policy Implications

Chapter 6 Conclusion

References
ABSTRACT