FRBSF Economic Letter
2006-12-13; June 2, 2006
Monetary Policy in a Global Environment
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This Economic Letter is adapted from remarks by
Janet L. Yellen, President and CEO of the Federal Reserve Bank
of San
Francisco,
delivered at the conference, "The Euro and the Dollar in
a Globalized Economy" at the University of California, Santa
Cruz on May 27, 2006.
My topic tonight is globalization and the conduct of U.S. monetary
policy. At issue is whether globalization has altered the inflation
process in the United States and, if so, whether such changes
impair the Fed's ability to assess the state of the economy or
to conduct monetary policy to achieve its dual objectives of
price stability and full employment.
Proponents of the view that globalization has affected U.S.
inflation commonly claim that it has resulted in disinflationary
pressures
over the last decade. For example, Alan Greenspan (2005) made
precisely this argument in Congressional testimony last year,
citing the massive new "army" of workers that has
become available to engage in the world's markets—some 100
million
plus from the former Soviet bloc, some 750 million from China,
and the growing powerhouse of talent that India's workers represent.
Beyond its direct impact on the level of U.S. inflation, proponents
of this "new view" contend that globalization has
altered the dynamics of inflation—the linkages between current
inflation,
lagged inflation, domestic unemployment, and supply shocks
that are summarized by the Phillips curve. In particular,
their view
is that globalization has weakened the traditional link between
domestic resource utilization and inflation: With prices
increasingly set in global markets, firms have less room
to pass on higher
costs—whether due to wages, energy, or materials prices; instead,
they have to do what they can to control costs, identify
productivity improvements to offset cost increases, and ultimately
absorb
any fluctuations in unit costs in their profit margins. As
The Economist (2005) recently opined: "This makes a nonsense
of traditional economic models of inflation, which virtually
ignore globalization…." Some observers go even
further, arguing that the slack that matters to inflation
is not domestic
slack but global slack (see, for example, Fisher 2005).
My objective in these remarks is to discuss several conceptually
distinct channels through which globalization might affect
the process of inflation in the United States, to assess
some empirical
evidence bearing on the strength of such linkages, and
to reflect on the implications for monetary policy.
To preview my conclusions, some very tentative evidence
supports the proposition that increasing global capacity,
on balance,
has held inflation down over the last decade. But, the
magnitude of the dampening effect appears to be modest,
and exchange
rate fluctuations, possibly related to other shocks,
have played a
significant role. There is also evidence that the (price-price)
Phillips curve has become flatter—a phenomenon that
may be related to globalization.
With respect to monetary policy, I find nothing either
in theory or the existing empirical evidence to overturn
the
conclusion
that a country like the United States, operating under
a flexible exchange rate regime, can ultimately achieve
the
inflation
target of its choice. That said, global factors may
impact inflation
in the medium term, just as higher productivity growth
is now widely recognized to have put downward pressure
on inflation
during the second half of the 1990s. And insofar as
globalization has affected the dynamics of inflation—through
changes
in the slope of the Phillips curve or the NAIRU (non-accelerating
inflation
rate of unemployment)—it may require some recalibration
of
policy responses.
Linkages between globalization and inflation
In discussing how globalization potentially affects
the inflationary process, it is common to focus on
a number
of distinct channels,
and I will follow that approach here. However, I
want to emphasize that, at least in some cases, these channels
represent partial
effects that may have repercussions on other variables—such
as the exchange rate—in a fully specified model.
Movements
in these other variables may materially affect one's
views
on the
impacts of globalization. However, I will defer that
consideration until I turn to assessing the interpretation
of the empirical
results in the literature.
The first channel is the most obvious one—the direct
effect of the reductions in the prices of imported
goods and services
that may be caused by globalization, and which are
included in the indices of consumer prices that central
banks
commonly target.
Import prices also could have indirect impacts on
inflation. One such indirect linkage might operate
through the
labor market if nominal wage demands are influenced
by the
prices of imported
consumer goods. The argument here is that a decline
in the price of imports raises the real reward to
work, namely, the purchasing
power of a given nominal wage. Such real wage increases
may
raise labor supply. Alternatively stated, lower import
prices could
reduce workers' demands for nominal wage increases.
Another indirect channel reflects the possibility
that lower import prices may restrain the prices
charged
by domestic
producers of competing products. Increased global
competition, as the "new
view" emphasizes, may
have made the demand curve facing American producers
more elastic, resulting
in larger feedbacks
from lower import prices into core inflation. The
now standard practice of including import prices
in the price-price or wage-price
Phillips curve provides a way to capture both direct
and indirect linkages from import prices to domestic
inflation.
In addition, this constraint on pricing ability could
affect other parameters in Phillips curves. This
effect might
operate in a couple of ways. First, when lower domestic
unemployment
leads to higher wage demands, firms may not be able
to pass through the higher costs, but must absorb
them in
their markups.
As a
result, a Phillips curve that expresses inflation
as a function of slack, lagged inflation, and other
variables
(the so-called
price-price Phillips curve) would become flatter—with
a smaller response of inflation to measures of slack—as
the "new
view" emphasizes. This result would hold even
if the response of wage growth to slack were unchanged.
However, it is also possible that globalization could
reduce the sensitivity of domestic wages to changes
in domestic
labor market slack—in other words, it also could
make the wage-price
Phillips curve flatter. Suppose, for example, that
globalization has enhanced the opportunities for
firms to substitute
imports for domestic output. This could occur in
part because firms
operating plants in several countries may be able
to shift production from
plants in the U.S. to those in lower-cost countries.
As such opportunities for substitution increase,
firms might
become
less willing to grant wage increases that would impair
their cost
competitiveness, even in the face of tight domestic
labor markets. Such substitution effectively increases
the
degree of competition
between domestic and foreign workers. In
the limit—when such substitution in effect creates
a single global
labor market—it
could be that global, not domestic, labor market
slack explains changes in U.S. wages and inflation.
A distinct but related possibility is that globalization
may be undermining the bargaining power of U.S. workers,
making
them more fearful of job loss, thus lowering wage
demands and holding
inflation down. This might show up as a downward
shift in the Phillips curve, similar to the impact
of more
rapid productivity
growth in the second half of the 1990s. However,
globalization is but one of several structural shifts
that may have
deepened worker insecurity, especially among less-skilled
workers.
These
shifts include increased use of domestic outsourcing
and skill-biased technological changes that have
decreased the demand for less-skilled
workers and constrained their wages in most sectors
of the U.S. economy. Alternatively, globalization,
coupled
with
technological change, may simultaneously have raised
the
bargaining power
of
many skilled workers with opposite effects on the
Phillips curve.
A final linkage from globalization to inflation worth
noting pertains to productivity. Some have argued
that increased
global competition has raised firms' incentives to
innovate and their
ability to achieve productivity improvements in part
via foreign outsourcing of intermediate goods, IT
services, and back-office
functions. Productivity growth (or its change), as
we saw
during the boom of the 1990s, may affect the dynamics
of inflation.
In essence, faster productivity growth matters to
inflation, at least for a time, because it holds
down cost pressures.
Stated differently, more rapid productivity improvements
make it easier
for firms to satisfy workers' aspirations for real
wage gains. Faster productivity growth thus tends
to lower
inflation unless or until workers' real wage aspirations
rise to
match
the productivity
gains.
Evidence from import prices
Several recent studies, employing different empirical
strategies, have attempted to assess the magnitude
of direct and indirect
linkages between import prices and inflation for
the U.S. and other industrial countries.
For example, a recent IMF (International Monetary
Fund 2006) analysis estimates (price-price) Phillips
curve
relations for a panel of eight industrial countries,
including the
U.S. The
study finds that the slower rise in relative import
prices in recent years has had only a fairly small
impact on
overall inflation.
For the U.S., the study estimates that a 1% decline
in relative
import prices lowers CPI inflation by only 15 basis
points after one year and 6 basis points after
three years.
Based on such
estimates, the IMF calculates that non-oil import
price reductions lowered U.S. inflation by an average
of
1/2 percentage point
a year over 1997 to 2005. These results are in
line with those from a recent analysis at the Federal
Reserve Board
that estimates
that lower (core) import prices have reduced core
U.S. inflation by an annual average of 1/2 to 1
percentage
point over the
past 10 years (Kohn 2005).
Another empirical strategy that has been used to
identify possible indirect effects of globalization
on pricing
by domestic producers
involves the use of sectoral data. The IMF study
I mentioned is representative. It finds that a
10% increase
in a
sector's import ratio—that is, the ratio of imports
to domestic
production—reduces its price relative to an index
of aggregate producer prices
by 1%. There is also some limited evidence that
manufacturing sectors
with rising import shares experienced lesser increases
in domestic unit labor costs and intermediate goods
costs than
the average
industry. This result is consistent with the hypothesis
that globalization is holding down wages in some
industries and
outsourcing may be lowering the costs of intermediate
goods. Nevertheless,
the estimated magnitude of the effects of openness
on producer prices is still rather small. Thus
in manufacturing, which
has perhaps been most impacted by globalization,
the IMF estimates that increased trade openness
has reduced
relative
producer
prices
by 0.3% per year between 1987 and 2003.
In light of China's rapidly growing economy and
exports and the limited flexibility of its exchange
rate
against the
dollar, proponents of the "new view" commonly
single that country out as a source of global disinflationary
pressures. However,
a Federal Reserve Board study focusing on the specific
impact of China on U.S. prices finds only modest
effects (Kamin, Marazzi,
and Schindler 2004). It estimates that a rise in
China=s share of imports in a particular sector
lowers U.S. import prices,
but this effect is not substantial. The results
imply that the roughly 0.6 percentage point per
year rise in China's share of
U.S. imports since 1993 has lowered U.S. import
inflation by about 0.8 percentage point per year.
With imports now only about
16% of U.S. GDP (in nominal terms), this translates
into an annual decline in U.S. consumer prices
of about 0.1 percentage point.
This study finds no evidence of indirect effects
of Chinese import prices on U.S. producer prices.
The array of evidence I have summarized thus far
suggests that foreign factors have had some impact
on U.S. prices—an
impact
that may be increasing—but overall it has
been rather limited. Such findings should not come
as
a great
surprise. Despite
the growing trend toward integration, the U.S.
is far—very far—from
being fully integrated with the rest of the world's
markets. As I just mentioned, imports still amount
to a fairly
small fraction of U.S. GDP. In addition, many U.S.
goods are
not traded, and
despite stories about U.S. firms hiring programmers
in Bangalore and typesetters in Beijing, they still
have
to "buy American" when
it comes to a host of other services and trades,
such as health care, entertainment, and construction.
The prices of these non-traded
goods and services, which represent the large majority
of domestic consumption, are not directly affected
by foreign price developments.
Therefore, domestic price developments arguably
still weigh far more heavily in the overall domestic
price level than do foreign
price developments.
Moreover, the evidence of small foreign effects
that I've discussed may actually overstate the
true effects
of globalization.
The
reason has to do with exchange rate adjustments.
It might seem obvious that if low-wage countries
like
China and
India have
a growing capacity to supply labor-intensive goods
to global markets, that would produce a persistent
downward
trend
in the dollar prices of U.S. imports. However,
the dollar prices
of
imported goods reflect not only the selling price
of these goods in foreign currencies but also movements
in the value
of the
dollar vis-à-vis those currencies. In many
theoretical models of an open economy with flexible
exchange rates, however,
a country's real exchange rate and its import prices
are not ultimately determined by foreign price
trends. In simple models,
changes in the foreign currency prices of imports
tend to be offset by movements in the exchange
rate, leaving domestic import
prices unchanged. In other words, a flexible exchange
rate hypothetically shields a country from the
direct effects of globalization.
Furthermore, the fluctuations that we have observed
in import prices—fluctuations which the Phillips
curve studies I've
discussed implicitly attribute to greater world
capacity—may actually
have resulted from conceptually distinct causes,
such as "capital
account shocks" affecting global capital flows.
For example, an appreciation of the dollar, and
a corresponding reduction
in import prices, would be expected in the aftermath
of a shock that widens the gap between desired
foreign saving and investment.
Such a shock arguably occurred in the wake of the
global financial crisis in 1997-98 and as a consequence
of Japan's banking crisis.
An increase in the return to investment in the
U.S. could similarly have induced capital inflows
that appreciated the dollar.
In support of the view that import price movements
have actually been driven at least in part by factors
unrelated
to "globalization," the
Board study I mentioned (Kohn 2005) finds that
movements in exchange rates have been at least
as important as movements in the foreign
currency prices of imported goods in accounting
for fluctuations in U.S. import prices. The importance
of exchange rate fluctuations
as a source of variation in import prices explains
why the IMF study finds large year to year variability
in the impact of import
prices on inflation. According to its estimates,
significant declines in non-oil import prices,
largely due to the appreciation
of the dollar, held down U.S. inflation by about
1 percentage point during 1998-1999, following
the Asian financial crisis,
and by 3/4 percentage point during the 2001-02
global slowdown. Such movements in the dollar
are neither simply nor obviously
related to the growing global capacity often cited
by proponents of the "new view."
Other findings
I have thus far summarized the findings of studies
that attempt to gauge the direct and indirect
effects of import
price
movements on inflation. As I noted earlier, globalization
could also
affect the Phillips curve in other ways. Unfortunately,
research bearing
on some of the linkages I discussed is scanty.
But a review of the literature suggests that
there is
substantial empirical
evidence
supporting the "new view" conclusion
that the (price-price) Phillips curve has flattened.
The evidence pertains to the U.S.
and also to other industrial countries.
For example, a study at the Federal Reserve Board
finds that the responsiveness of U.S. inflation
to measures
of domestic
capacity has fallen by roughly a third since
the mid-1980s (Roberts 2004). The IMF study cited
earlier
finds a
similar result for
the eight advanced countries, including the U.S.,
in its sample. While the empirical finding of
a flatter Phillips
curve appears
pervasive, this result could be open to differing
interpretations.
The IMF study presents evidence suggesting that
greater openness explains over half of this reduced
sensitivity.
A BIS (Bank for International Settlements) study
attempts to sort out the relative importance
of domestic and
global capacity
pressures by including both measures in Phillips
curve equations for a sample of 16 countries
(Borio and Filardo
2006). It
finds that a measure of world capacity is significant
in explaining
inflation and reduces the effect of domestic
capacity on inflation. Taken at face value, this
analysis
implies that
inflationary
pressures could remain contained in countries
where domestic resources are fully or more than
fully
employed as long
as there is excess capacity in the global economy.
However, I would need to see more evidence to
be convinced of this result. The use of aggregate
Phillips curve
methodology to analyze national wage and price
trends is commonly
justified by the assumption that labor and capital
are sufficiently
mobile across localities and regions in a single
country to justify
the vastly simplifying assumption of a single
national
labor market. Measures of sectoral shifts are
sometimes included
as
an additional variable in the Phillips curve
because such an assumption is stretched, even
in the case
of a single
country.
But if the assumption of perfect labor mobility
seems stretched at the national level, it remains
far,
far less plausible
at the global level. I would urge additional
research to assess
its robustness and clarify its appropriate interpretation.
Moreover, San Francisco Fed staff found that
measures of world capacity are not significant
when added
to the Phillips
curves
that they use to forecast inflation, and that
the usual measures of domestic labor and product
market
slack
retain their significance.
In addition, the staff examined a wage-price
Phillips curve and found no change in the coefficient
on
the unemployment rate in
recent years. In other words, this exercise also
suggests that domestic slack plays about the
same role in the
inflation
process
as it did previously. As I indicated in my discussion
of possible linkages from globalization to U.S.
inflation, the result also
suggests that, insofar as globalization has led
to a flatter
price-price Phillips curve, it is more likely
to have done so through changes in firms' ability
to mark up
costs in
setting prices than through changes in the effects
of domestic slack
on wage growth.
Implications for monetary policy
Let me now turn to the final portion of my remarks
and attempt a response to the question: What
implications does globalization
have for the Fed's conduct of monetary policy?
My main conclusion is that globalization has
no impact
on the
Fed's ability
to control inflation in the long run, although
structural shifts
associated
with globalization could, in principle, affect
the NAIRU,
the level of labor market slack associated
with price stability. That said, I am not aware of
persuasive evidence that it
has
done so. However, globalization may have an
effect on wage/price dynamics and, as such, may require
that monetary
policy
be recalibrated to take these changes into
account, much as
was required in the
latter half of the 1990s in response to the
surge in productivity growth.
Since the focus of so much empirical work pertaining
to globalization centers on import prices,
it seems logical to begin by considering
the consequences of import price shocks for
monetary policy.
The implications are straightforward, because
changes in the prices of imported goods, whatever
their
cause, are
akin from
a policy perspective to other "supply shocks," such
as a change in the price of oil. Ever since the 1970s, such "shocks" have
routinely been incorporated in the Phillips curve models used
to forecast inflation, and their policy implications are well
understood. The consensus among economists is that "one-shot" changes
in the prices of imported commodities, such
as oil, impact inflation for a time, but not
permanently, unless they touch off a change
in inflation expectations, setting off a wage-price
spiral as
in the 1970s. Appropriate policy actions by
the Fed—a credible commitment to price stability
consistently backed by actions
to anchor inflation to price stability—are
essential to ensure that such supply shocks
do not become embedded in inflation expectations.
The Fed has learned a great deal since the
1970s about the dangers
such shocks pose to inflation outcomes absent
appropriate monetary policies and a commitment
to price stability. Indeed, the Fed
by now has established such a strong and credible
record that empirical evidence suggests that
there has actually been less
spillover of import prices, including energy
prices, into core inflation since the mid-1980s
It is conceivable, of course, that the forces
associated with globalization might result
not in "one-shot" type shifts,
affecting the level of relative import prices over a short period,
but a tendency instead for upward or downward pressures over
a prolonged period. Such long-lasting shifts in the relative
price of imports would create tailwinds for policymakers—if,
for example, rapid growth in global supply places prolonged downward
pressure on import prices—or headwinds, if, for example, strong
global growth instead produces a chronic upward trend in relative
commodity prices. The possibility of prolonged downward pressure
on import prices due to the integration of China and other emerging
markets in the global economy is presumably what Greenspan and
others have in mind when they describe globalization as a disinflationary
force. As the logic of the Phillips curve makes apparent, such
long-lasting shifts in import prices would indeed require the
Fed to adjust its monetary policy to keep overall inflation in
the vicinity of the Fed's preferred target. To combat the "headwinds" associated
with chronically rising import prices, monetary
policy must be tighter, which entails greater
slack in the labor market. Tailwinds
due to falling import prices, in contrast,
lower the degree of slack required to attain
a fixed inflation objective. It is in
this sense that ongoing negative supply shocks
raise the NAIRU, while ongoing positive supply
shocks lower the NAIRU.
A continued and pronounced downward trend in
relative import prices would impact the U.S.
inflation process
in a manner
akin to the productivity speedup in the 1990s—a
prolonged, positive
supply shock from a Phillips curve perspective.
Indeed, some have hypothesized that globalization
may actually
have spurred
some of the innovations that caused productivity
to surge. More rapid productivity growth, which
the U.S.
still
enjoys, enabled
the Fed to keep unemployment at extraordinarily
low levels for an extended period while simultaneously
bringing
inflation down
to levels consistent with price stability.
The productivity
speedup, coupled, in fact, with a marked reduction
in import prices associated
with the appreciation of the dollar in the
latter half of the 1990s, made the Fed's job
a great
deal easier.
In addition to linkages to inflation that operate
through the channel of import prices, my earlier
discussion
highlighted the possibility that globalization
could account for
the flatter
(price-price) Phillips curve. To my mind, such
changes in the slope of the Phillips curve
have no obvious
implications for
the Fed's ability to achieve its dual objectives
of price stability and full employment. However,
a flatter
Phillips
curve could
complicate the Fed's job by making policy errors
both easier to commit and more costly to repair.
Reduced
sensitivity of inflation
to domestic unemployment means that emerging
inflationary pressures take longer to become
evident and are
more difficult
to discern.
As a consequence, the Fed might be tempted
to let these pressures
build up, taking comfort from the fact that
the inflationary consequences appear to be
small
or nonexistent. Such
reasoning is misguided, however, because reduced
sensitivity of inflation
to slack simultaneously raises the sacrifice
ratio, which is the cost of restoring price
stability once inflation
has unacceptably
risen.
I have implicitly assumed in my discussion
so far that the Fed's ability to influence
aggregate
demand
and
thereby inflation
is
unaffected by globalization. This assumption
arguably requires some defense because the
growing integration
of capital
markets—another aspect of globalization—has
increased the sensitivity of
global capital flows to interest rate differentials
and expectations concerning exchange rate movements.
Do linkages
among interest
rates rob monetary policy of its power to affect
demand? My
answer to this question is no. I base it on
both economic theory and
the evidence. Of critical importance to the
effectiveness of monetary policy with highly
integrated global
capital markets
is that the U.S. operates under a regime of
flexible, not fixed, exchange rates. Under
a fixed rate
regime, the Fed
would indeed
have little or no scope to influence spending.
For example, a contractionary open market operation
intended
to decrease
bank
reserves and raise domestic interest rates,
thereby inhibiting spending, would induce capital
inflows
forcing the Fed
to defend its currency peg by acquiring foreign
exchange. Such
offsetting
exchange reserve flows add to bank reserves,
in effect nullifying the original policy action.
A flexible exchange rate regime makes a world
of difference to monetary policy. Free of the
obligation
to defend
any currency peg, the Fed retains control over
its monetary base. Since
the
U.S. is a large player in the global economy
and in capital markets, U.S. monetary policy
commonly
impacts
both interest
rates and
the value of the dollar. Repercussions of monetary
policy on the dollar typically occur to the
extent that capital
flows
are sensitive to global interest rate differentials.
The
transmission mechanism for U.S. monetary policy
operates through both channels
of influence which work in tandem to affect
aggregate demand. The tendency of the dollar
to appreciate
in response to
a tighter monetary policy also creates a direct
link to inflation
via
lower
import prices.
From the perspective of monetary policy, there
is one notable asymmetry affecting the Fed's
ability to combat
any "headwinds" or "tailwinds" associated
with globalization. The asymmetry results from the so-called
zero bound on nominal interest rates—which sets a lower limit
on the federal funds rate below which it cannot go should the
Fed need to stimulate the economy to counter deflation. With
sufficiently intense deflationary "tailwinds," the
Fed could conceivably exhaust its scope for
response, at least using conventional policy
approaches. In fact such risks became
palpable in 2003—for the first time in half
a century. This episode stimulated not only
thoughtful policy research but also
a creative and constructive response on the
part of the Fed.
I will conclude by summarizing
the main themes
in this talk and emphasizing the value of
additional research.
The evidence
I
reviewed suggests that shifts in the relative
price of imports—one mechanism through which
globalization
might
affect U.S. inflation
performance—have thus far been relatively
modest. Evidence also suggests that the Phillips
curve
has
flattened,
a phenomenon that could be related to globalization.
There
are a number
of
additional channels through which structural
changes associated with globalization could
affect labor
and product markets,
and these changes could, in turn, alter the
NAIRU, possibly for an
extended time. Unfortunately, existing evidence
pertaining to the operation of these various
linkages is scanty
or nonexistent. To the best of my knowledge,
econometric estimates
of the
U.S. Phillips curve provide no obvious evidence
of any pronounced shift in the NAIRU in recent
years.
From the perspective of monetary policy,
globalization does matter. Shocks and persistent
economic
trends associated with America's
involvement in the global economy must
be factored into the
design of an appropriate monetary policy.
Even so, globalization does
nothing to imperil the Fed's ability to
attain its inflation objectives. We still have a
lot to learn
about the mechanisms
through which globalization is impacting
the U.S. economy. As the globalization
trend unfolds,
we
policymakers will turn to
you, our colleagues in the economics profession,
for
the best in theory and evidence to guide
us. Janet L. Yellen
President and Chief Executive Officer
References
[URLs accessed May 2006.]
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Current Account Deficit." Remarks delivered at the Homer
Jones Lecture, St. Louis, MO, April 14.
Borio, Claudio, and Andrew Filardo. 2006. "Globalisation
and Inflation: New Cross-Country Evidence on the Global Determinants
of Domestic Inflation." Mimeo. Bank for International
Settlements (March).
Clarida, Richard, Jordi Galí, and Mark Gertler. 2001. "Optimal
Monetary Policy in Open versus Closed Economies: An Integrated
Approach." American Economic Review 91(2) (May), pp.
248-252.
Economist, The. 2005. "A Foreign Affair." Print version,
p. 81 (October 20).
Fisher, Richard. 2005. "Globalization and Monetary Policy." Warren
and Anita Manshel Lecture in American Foreign Policy,
Harvard University, Cambridge, MA, November 3.
Greenspan, Alan. 2005. Testimony
before the Joint Economic Committee, November 3.
International Monetary Fund. 2006. "How
Has Globalization Affected Inflation?" World Economic Outlook,
Chapter 3 (April).
Kamin, Steven, Mario Marazzi, and John Schindler. 2004. "Is
China 'Exporting Deflation'?" Federal Reserve
Board of Governors International Finance Discussion
Paper 2004-791 (January).
Kohn, Donald L. 2005. "Globalization, Inflation, and Monetary
Policy." Remarks delivered at the James R. Wilson
Lecture Series, The College of Wooster, Wooster, OH,
October 11.
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Paper 2004-62.
Footnotes
As a result, markups would show stronger cyclical variation.
For
an analysis of how greater openness and increasing elasticity
of substitution can affect the slope of the Phillips curve, see
Clarida, Galí, and Gertler (2001).
A model that captures many of the factors described here
is in Bean (1994).
4 Since the 1960s, U.S. import prices, both core and overall,
have risen at about the same annual rate as consumer prices—roughly
4%. But since 1997, core import prices (excluding petroleum,
natural gas, computers, and semiconductors) have risen only 0.4%
per year, versus 1.7% for core consumer prices (PCE price index).
The
IMF’s counterfactual calculations assume that relative
non-oil import prices moved during the 1997-2005 period
in line with an historical trend decline of 1.6% per year. Note,
however, that this decline reflects the inclusion of computers
and semiconductors; if those elements are removed, as they are
in the Federal Reserve Board’s measure of core import prices,
then there is no trend decline.
For a fuller discussion of these points and their implications
for the U.S. current account deficit, see Bernanke (2005).
It should be noted that in the case of the U.S. the impact
of lower foreign prices during this time was augmented by an
appreciating dollar, part of which may have endogenously reflected
currency depreciations by emerging markets needing to improve
their current account balances.
In the limiting case in which domestic inflation is completely
unresponsive to movements in domestic slack, Fed-engineered changes
in aggregate demand
would have no direct impact on inflation, nullifying the normal mechanism
by which the Fed controls inflation. However, tighter monetary
policy would likely
still affect inflation directly, to the extent that interest rate differentials
induce capital flows that appreciate the exchange rate.
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do not necessarily reflect the views of the management
of the Federal Reserve Bank of San Francisco or of the
Board of Governors of the Federal Reserve System. Comments?
Questions? Contact
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