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Friday, March 02, 2007

Bernanke: Globalization May Have Increased Inflation

Continuing with the post below this one... Recently, it was reported that the relationship between changes in the real economy and changes in the inflation rate is lower than it used to be, something discussed here. Below, Federal Reserve Chairman Ben Bernanke is reported as saying he agrees with these findings:

The relationship between slack in the economy and lower inflation is ''clearly lower'' than it used to be.

Another aspect of the recent debate over monetary policy concerns how globalization has affected inflation, and the Fed's ability to affect inflation through monetary policy. Here's Chairman Bernanke's view, a view that agrees with what I've been arguing:

Bernanke Says Globalization May Boost U.S. Inflation, Reuters: Global factors may on balance have boosted U.S. inflation, but globalization has not affected the ability of the Federal Reserve to influence U.S. financial conditions, Fed Chairman Ben Bernanke said on Friday.

''When the offsetting effects of globalization on the prices of manufactured imports and on energy and commodity prices are considered together, there seems to be little basis for concluding that globalization overall has significantly reduced inflation in the United States in recent years; indeed the opposite may be true,'' he said in a speech at Stanford University. ...

The central bank chief said the Fed finds it difficult to pin down a fixed number for any natural rate of unemployment. ''There are a couple of problems that have emerged with using a fixed number like that for analyzing the macro-economy,'' he said.

The relationship between slack in the economy and lower inflation is ''clearly lower'' than it used to be, Bernanke said.

Bernanke said that globalization has not ''materially affected the ability'' of the Fed to influence U.S. financial conditions, ''nor has it led to significant changes in the process which determines the U.S. inflation rate.''

Overall, globalization has probably spurred inflation in the United States rather than lowered it because recent increases in energy and commodity use in developing countries such as China and India have pushed up prices for such goods, Bernanke said.

He noted a study that found that if the share of world trade and economic growth of non-industrial countries remained at its 2000 level, oil prices would have been as much as 40 percent lower in 2005 and metals prices as much as 10 percent lower.

''Accordingly, in the past several years, the effect of growth in developing economies on commodity prices has been a source of upward pressure on inflation in the United States and other industrial economies,'' he said.

At the same time, increased trade with China and other developing countries has led to slower growth in the prices of imported manufactured goods, Bernanke said.

He cited a study concluding that trade with China alone reduced annual import price inflation in the United States by about 1 percentage point over 1993-2002.

The Fed is devoting more resources and time to trying to understand the effect of increased global integration on inflation and the central bank's ability to maintain price stability and ensure low unemployment, Bernanke said. ...

Update: Here is the speech, "Globalization and Monetary Policy."

Update 2: Here are a few quotes from the speech at Stanford with some of the discussion of the supporting research, e.g. the work on the "global output gap hypothesis" that is part of the recent discussion about the changing relationship between domestic real activity and inflation. One reason we ,ight see a declining relationship between the output gap and inflation is that the relevant concept of the output gap has changed while our measurement of the gap - domestic output minus domestic potential output (which is shaky in any case) - has not. Thus, it is not that the output gap and inflation are unrelated, i.e. that the Phillips curve is dead, but rather the appropriate definition of the gap to use in assessing the relationship has changed. There are quite a few more references and a lot more discussion in the speech itself:

The empirical literature supports the view that U.S. monetary policy retains its ability to influence longer-term rates and other asset prices. Indeed, research on U.S. bond yields across the whole spectrum of maturities finds that all yields respond significantly to unanticipated changes in the Fed’s short-term interest-rate target and that the size and pattern of these responses has not changed much over time (Kuttner, 2001; Andersen and others, 2005; and Faust and others, 2006). Empirical studies also find that U.S. monetary policy actions retain a powerful effect on domestic stock prices.

...

I draw two conclusions... First, the globalization of financial markets has not materially reduced the ability of the Federal Reserve to influence financial conditions in the United States. But, second, globalization has added a dimension of complexity to the analysis of financial conditions and their determinants, which monetary policy makers must take into account.

...

International factors might affect domestic inflation through several related channels. First, the expansion of trade may cause domestic inflation to depend to a greater extent on the prices of imported goods--not only because imported goods enter the consumer basket or (in the case of imported intermediate goods) affect the costs of domestic production, but because competition with imports affects the pricing power of domestic producers. Second, competitive pressures engendered by globalization could affect the inflation process by increasing productivity growth, thereby reducing costs, or by reducing markups. Third, to the extent that some prices are set in internationally integrated markets, pressures on resource utilization in foreign economies could be relevant to domestic inflation.

Some analysts might object to the proposition that globalization affects the inflation process at all on the grounds that the structural changes that globalization engenders can affect only the relative prices of goods and services; in contrast, inflation--the rate of change of the overall price level--must ultimately be determined solely by monetary policy (Ball, 2006). Certainly, monetary policy determines inflation in the long run, and the central bank must take responsibility for the inflation outcomes generated by its policies. ...

However, the conclusion that inflation is determined only by monetary policy choices need not hold in the short-to-medium run.

...

In a globalized economy, the level of resource utilization in the world economy is another potential influence on domestic inflation. Standard analyses of inflation based on the concept of a Phillips curve assign a role in inflation determination to the domestic output gap--the difference between the economy’s potential output and its actual production. According to this theory, the existence of slack in the economy makes it more difficult for producers to raise prices and for workers to win higher wages, with the result that inflation slows. These conventional analyses have considered only the possible link between domestic inflation and the domestic output gap. But in an increasingly integrated world economy, one may well ask whether a global output gap can be meaningfully defined and measured and, if it can, whether it affects domestic inflation. In other words, all else being equal, would a booming world economy increase the potential for inflationary pressures within the United States?

In principle, with the domestic determinants of inflation held constant, reduced slack in the global economy could increase domestic inflation for a time if it led to higher prices for some traded goods and services relative to the prices of goods and services that are not usually traded. For example, suppose that the United States produces personal computers both for export and for domestic use, and that more-rapid growth abroad increases the world demand for computers. Stronger global demand for computers raises the prices that U.S. producers can charge their foreign customers. Moreover, because all computer producers are facing a stronger global market, U.S. producers can charge more for their output at home as well. If producers of many goods face increases in worldwide demand, the net effect could be higher inflation in the United States, even though there may be no measurable effect on the prices of U.S. imports.

The idea is intriguing but again, unfortunately, the evidence is so far inconclusive. Early work, including some done at the Federal Reserve Bank of Boston, found no effect of global demand conditions on U.S. inflation, as did most of the subsequent research. Recently, however, several researchers affiliated with the Bank for International Settlements (BIS) have reported results favorable to the global output gap hypothesis (Borio and Filardo, 2006).

    Posted by on Friday, March 2, 2007 at 10:40 PM in Economics, International Finance, International Trade, Monetary Policy | Permalink  TrackBack (0)  Comments (13)

          

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