Impacts of Globalization on Monetary Policy
In his beautifully scripted paper, “Impacts of Globalization on Monetary Policy” Kenneth Rogoff explores the roles played by globalization on monetary policies that domestic central banks adopt in their endeavors of inflation and output stabilization. To achieve this he explores various perceived global financial variables that are associated with shifts in asset price volatility including exchange rates volatility. He sums his paper into the following three questions; “(1) Are global factors becoming important drivers of domestic inflation – or disinflation? (2) To what extend should terms of trade shocks play a larger role in central rules for deciding when and for how long to allow inflation to drift above or below target? (3) Even if central banks are reluctant to react to perceived misalignments in asset price levels, how concerned should they be about the fact thus far, equity, housing and trade-weighted exchange rates have not yet demonstrated the enduring decline in volatility that output and inflation have experienced?” [Rogoff, (2006) p.1]
Rogoff revisits numerous research works conducted by great economists in view of providing a theoretical basis to his paper. He does not offer anything new to us but he cleverly expound on what others unearthed, however, he does not fail to disagree where necessary, of importance is that he agrees with others alike that globalization plays a huge role in the shaping of domestic inflation trends and the formulation monetary policies by independent countries.
He begins by disapproving the notion that “China exports deflation” and instead supports the opposite; that China really “exports inflation” through its hyper-competitive exports that are sold at relatively low prices compared to global price trends. Globalization has demonstrated that it contributes to low inflation rates as Rogoff asserts, through creation of strong competition which goes on to make domestic monopolies and labor unions frail and hence leading to high prices for goods and lithe wage trends while reducing output gains in the short term in favor of long term gains. [p. 6] However, Rogoff hints that the above phenomenon is conditional that, the private sector picks up as quickly as central banks on terms of trade and productivity trend-shocks as happened in the 1990s. [p. 8]
In regards to global excess capacity, Rogoff advices that central banks should be on the look out for trade shifts and global excess capacity volatility so as to fix domestic excess capacity. Nevertheless he reassuringly points out that central banks have got the capability of stabilizing domestic price if they possess the will power to do so. On a negative note, globalization can take a reverse turn especially due to factors such as oil shocks and therefore hurt the domestic economies of countries that rely almost entirely on imported oil. [p. 10] Inasmuch as central banks are able to stabilize domestic price levels and inflation, globalization has a substantial impact on real interest rates and asset prices, for instance cross border financial claims and direct foreign investments are the order of today’s monetary trends. Interestingly real interest rates on long-term US, German, and Japan government bonds have been observed to assume similar pricing levels an indicator that there is a substantial globally pressure to converge prices of similar goods. [p.11]
Rogoff associates the global striking variance that has been noted between the sharp decline in the volatility of real output and the continuing volatility of asset prices and the “Great Moderation” of stock price volatility to better monetary policies. On the question of whether the exchange rate or terms of trade should enter directly into the monetary policy rule, Rogoff settles for a moderate point of view and leaves the decision to domestic central banks to choose depending on which policy they adopt, either the “Taylor rule” or the strict inflation target rule. However, he does not leave the subject unaddressed as he points out that the incorporation of exchange rate and terms of trade into monetary rule may be counteractive as they are both hard to explain due to their asset price nature rather than a price for trading goods. [Pp.21-24]
In conclusion, Rogoff cautions central banks to be extra vigilant as they are charged with the core responsibilities of making sure that their institutional machinations that preserves the low trend inflation stay firm in order to cushion any unexpected shocks that may be brought about by globalization. [p. 26]
Rogoff, Kennedy, (2006); Impacts of Globalization on Monetary Policy, August 28, 2006, accessed on February 5, 2009