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April 24, 2007
Does Globalization Make Monetary Policy Harder?
According to the Financial Times, the answer is "maybe", but the message is a bit tricky. On the one hand:
... Take the renewed worries about how energy costs might contribute to broader price pressures...
Such cost contagion is, of course, not enough to cause inflation expectations to rise. Rather, it broadly shows markets doing their job in reacting to changes in relative prices. Higher oil prices encourage the use of substitutes. They also shift demand to goods and services less affected by the shock. As long as monetary policy remains steady, the end-result would still be painful but not inflationary.
That is right on target, but:
... According to conventional wisdom, globalisation has been one of the chief reasons why the loose monetary policy of the past decade has not translated into swifter consumer price inflation. Cheap imports from India and China were said to have eroded the pricing power of, say, US companies at home.
That view always raised a few questions, such as how long any such damping effect might last. Intriguingly enough, rising oil prices may already have caused it to wane.
Since the "cheap import" phenomenon is just another variant of "changes in relative prices", the article's first observation is perfectly apt: "As long as monetary policy remains steady, the end-result would still be painful but not inflationary." But the author of the article apparently has something a little more complicated in mind:
Recent research by two economists, Paul Bergin and Reuven Glick, suggests prices of a wide range of goods did indeed converge globally – until about 1997. Since then, prices have drifted apart again, perhaps owing to rising transport costs.
Here, more specifically, is what Bergin and Glick uncover:
This paper documents significant time-variation in the degree of global price convergence over the last two decades. In particular, there appears to be a general U-shaped pattern with price dispersion first falling and then rising in recent years, a pattern which is remarkably robust across country groupings and commodity groups... However, regression analysis indicates that this time-varying pattern coincides well with oil price fluctuations, which are clearly time-varying and have risen substantially since the late 1990s. As a result, this paper offers new evidence on the role of transportation costs in driving international price dispersion.
The implication seems to be that globalization -- increasingly open trade, more precisely -- has introduced patterns in observed prices that make it more difficult to disentangle relative price changes from trend inflation. There does not yet appear to be much evidence of such a problem appearing in the behavior of long-term inflation expectations:
Nonetheless, it is worth thinking about the FT's suggestion that the types of influences identified by Bergin and Glick "could make monetary policy a lot trickier going forward."
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