Offshoring and Inflation

Did trade integration suppress inflation? Conventional wisdom says yes, based on the disinflationary supply-side impacts of trade. These supply-side arguments are incomplete however, because trade dynamics also influence aggregate demand. We analyze how trade dynamics shape inflation in New Keynesian models, depending on whether trade is changing for inputs versus final goods, whether shocks are anticipated versus unanticipated, and whether they are transitory versus persistent. Specifically, we stress that anticipated and persistent increases in future trade raise inflation today. Consistent with this channel, we show that inflation increases before and after countries adopt free trade agreements, which contain news about future increases in trade. Embedding this mechanism into extended models with pro-competitive and distributional effects of trade, we find that rising trade in the United States led to higher inflation between 1995 and 2010, with a reversal thereafter as trade integration stalled.