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Wednesday, October 12, 2005

Fed Governor Kohn on How Globalization Affects Inflation and Monetary Policy

In addition to Greenspan's remarks today noted here, Fed governor Donald Kohn, discusses globalization, inflation, and monetary policy in a speech given yesterday.

it remarks by Alan GrHe believes globalization has, so far, produced modest disinflationary pressures within the U.S. due to the falling price of imports, but this will not necessarily continue into the future. Thus, globalization has contributed, but only modestly, to the Fed's goal of price stability. With respect to the Fed's other goal, high employment, Kohn recognizes that there may be higher structural unemployment during the transition period to globalization, but feels the effects are minor and leave overall employment little affected while expanding the economy's productive potential. The bottom line for how gobalization has affected his job as a central banker is, "The need to compete for business in a globalized economy has quite likely raised the efficiency and flexibility of economic systems as well as reinforcing the requirement for noninflationary monetary policies...":

Globalization, Inflation, and Monetary Policy, by Donald L. Kohn: ...I intend to spend much of the ... time discussing the ... effects of the process of globalization on my job as a central banker. ... I have been struck recently by the contrast between the views reported in the media and views among academic economists on this issue of globalization and inflation. The media tend to concentrate on the increasing availability of cheap goods and competitive pressures on labor compensation as a continuing ... check on inflationary tendencies in industrial economies. In contrast, just two weeks ago, I attended a conference of leading academic and central bank researchers on inflation ... at which globalization was hardly mentioned. One modeler had tacked an import price variable onto the equations explaining U.S. inflation, but the rest simply ignored any developments beyond our borders. ... The academic view implies that for the most part I can proceed with regard to inflation as if the United States is, to a first approximation, a closed economy. To act as if the outside world does not matter flies in the face of the major changes we have witnessed in recent decades. The advance of globalization has ... directly held down the rate of increase of the imported-goods component of the consumer price index (CPI) and, thus, the rate of increase of the overall index; ... Globalization has reinforced disinflation by intensifying the competitive pressures faced by U.S. firms and workers. ... For workers in some sectors, labor compensation has likely been restrained by the threat of jobs being shifted overseas ... and this wage restraint in turn has helped to hold down domestic prices.

How important have these direct and indirect price effects been? A precise answer to this question is beyond our abilities, but ... although not necessarily inconsequential. ... imports have had at most only modest effects on U.S. prices in recent years, although more-significant effects were recorded in a few specific categories... In addition, ... historically, industrializing countries have often raised global demand more than supply. Somewhat surprisingly, however, a number of these countries are currently producing more than they are spending. Their trade accounts tend to be in surplus, in some cases substantially, an indication that they are supplying more goods into the global economy than they are demanding. ... For a variety of reasons, some emerging-market economies have resisted upward pressures on their exchange rates, even if that resistance requires buying large quantities of dollars to keep their currencies from appreciating. ... less than fully flexible exchange rates are probably contributing to the surpluses of these economies and to their disinflationary effect on the rest of the world. Taking all these factors into account, where do I come out on the question of how recent trends in globalization have affected inflation in the United States and other industrial countries? On balance, under current circumstances, the entry of China, India, and others into the global trading system is probably having a modest disinflationary effect here. But it is neither large nor inevitable. ... we cannot rule out the possibility that globalization might some day even create inflationary pressures on balance.

If globalization is having a modest but persistent downward effect on U.S. inflation, what about its effects on employment, the other component of the Federal Reserve's dual mandate? Here, I think the answer is clearer: An expansion of trade does not impinge on an economy's ability to create jobs and operate at its potential, given time for any temporary sectoral disruptions to be worked out. ... That we now have an unemployment rate as low as 5 percent, and have sustained that rate without an appreciable pickup of underlying inflation, is evidence that our economy's ability to provide jobs on a sustained basis has not been impaired. Although globalization should have little effect on aggregate employment..., international trade does expand the economy's productive potential. By ... permanently raising the level of potential output... Globalization in its latest manifestations does not relieve central banks of their responsibility for maintaining price and economic stability. ... How the forces of demand, potential supply, and expectations interact has probably not been changed in any fundamental way by the recent trend of globalization. ... the ... extent and duration of its damping influence on inflation in the future are open questions. ... To the extent that the U.S. can more readily draw upon world capacity, the inflationary effect of an increase in aggregate demand might be damped. But from another perspective, integrated economies and financial markets can also exert powerful feedback, which may be less forgiving of any perceived policy error. ... The need to compete for business in a globalized economy has quite likely raised the efficiency and flexibility of economic systems as well as reinforcing the requirement for noninflationary monetary policies...

    Posted by on Wednesday, October 12, 2005 at 10:11 AM in Economics, Fed Speeches, Inflation, Monetary Policy | Permalink  TrackBack (0)  Comments (1)

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