Staff Working Paper No. 1,060
By Tommaso Aquilante, Aydan Dogan, Melih Firat and Aditya Soenarjo
This paper explores the link between the UK’s participation in global value chains (GVCs) and inflation dynamics. Using sectoral data, we find evidence indicating that UK industries with higher proportions of imported inputs from emerging market economies (EMEs) exhibit a flatter Phillips curve. We then build a two-country model with input-output linkages and demonstrate analytically that an increased reliance on imported intermediate goods, serving as a proxy for GVCs, results in a flatter Phillips curve. Additionally, GVC integration affects inflation dynamics through the influence of cyclical forces that shape firms’ marginal costs via terms of trade fluctuations. Specifically, we highlight how the limited business cycle correlation between the UK economy and EMEs reduces the pass-through of domestic shocks to prices.