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Saturday, November 05, 2005

Globalization and Monetary Policy

Dallas Fed president Richard Fisher does not like trying to conduct monetary policy without fully understanding how the global economy feeds back into the domestic economy and affects variables like inflation, the output gap,  and unemployment. He wants an updated Phillips curve to use for monetary policy, one that incorporates the consequences of globalization:

Globalization and Monetary Policy, by Richard W. Fisher, Dallas Fed President:  ...The literature on globalization is large. The literature on monetary policy is vast. But literature examining the combination of the two is surprisingly small. ...[I]n Michael Woodford’s influential book Interest and Prices: Foundations of a Theory of Monetary Policy, the word “globalization” does not appear in the index. Nor do the words “international trade” or “international finance.” What gives? Is the process of globalization disconnected from monetary policy? Is the business of the central bank totally divorced from globalization? I think not. I believe globalization and monetary policy are intertwined in a complex narrative that is only beginning to unfold. ... Where does monetary policy come into play in this world? Well, consider the task of the central banker, seeking to conduct a monetary policy that will achieve maximum sustainable non-inflationary growth. ... Central bankers want GDP to run at no more than its theoretical limit, for exceeding that limit for long might stoke the fires of inflation. They do not wish to strain the economy’s capacity to produce. ... Until only recently, the econometric calculations of the various capacity constraints and gaps of the U.S. economy were based on assumptions of a world that exists no more. ... The destruction of communism and the creation of vast new sources of inputs and production have upset all the calculations and equations that the very best economics minds, including those of the Federal Reserve staff—and I consider them the best of all—have used as their guideposts. The old models simply do not apply to the new, real world. This is why I think so many economists have been so baffled by the length of the current business cycle and the non-inflationary prosperity we have enjoyed over the past almost two decades. ... From this, I personally conclude that we need to redraw the Phillips curve and rejig the equations that inform our understanding of the maximum sustainable levels of U.S. production and growth. ... [H]ow can we calculate an “output gap” without knowing the present capacity of, say, the Chinese and Indian economies? How can we fashion a Phillips curve without imputing the behavioral patterns of foreign labor pools? How can we formulate a regression analysis to capture what competition from all these new sources does to incentivize American management? Until we are able to do so, we can only surmise what globalization does to the gearing of the U.S. economy, and we must continue driving monetary policy by qualitative assessment as we work to perfect our quantitative tool kit. At least that is my view. ...

    Posted by on Saturday, November 5, 2005 at 01:04 AM in Economics, Fed Speeches, Inflation, International Finance, Monetary Policy | Permalink  TrackBack (2)  Comments (5)

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