In an integrated world, inflation will be transmitted across national borders through commodity arbitrage. Hence, price throughout the world will eventually converge. Taiwan is a typical, small, open economy because Taiwan’s foreign trade, while accounting for a large part of the domestic economy, actually represents only a small portion of total world trade. Taiwan, therefore, in the world market is a price taker, and the inflation that occurs in the outside world will then induce an inflation in Taiwan of a similar degree.
From empirical evidence, we know that the export prices, and also the general domestic prices, of the United States, Japan, and more than twenty other countries that trade heavily with Taiwan – that is, heavily from Taiwan’s point of view – have an almost one-to-one impact on the general domestic price level in Taiwan.
The study also shows that in terms of price adjustment in Taiwan there is a time lag of between one and one-half and two years before Taiwan’s domestic – prices fully reflect a change in the world price level. One factor that has caused the price in Taiwan to deviate from the world price in the short run is that the domestic money supply and government expenditures have expanded relatively faster than the GNP growth rate, the other is the sharp increase in the unit labor costs of manufacturing industries.
