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Globalisation and the convergence of inflation rates

William R WhiteEconomic Adviser and Head of MED, Bank for International Settlements

Presentation at Barclays Capital 11th Annual Global Inflation-Linked Conference, Key Biscayne, Florida 28-30 January 2007

A presentation in four parts

� The facts about inflation

� Alternative explanations� Alternative explanations

� Prospects and exposures

� Implications for policy regimes

Part 1: The facts

� Inflation has fallen globally

� So too has inflation volatility

� And the inflation process has changed

Inflation and volatility have fallen

The inflation process has changed

� Inflation expectations seem better anchored

� Persistence has declined

� Pass-through is lower

� The responsiveness of inflation to domestic slack is down

� While the responsiveness to global slack seems to have risen

Part 2: Alternative explanations

� Effective central bank policy?

� The “savings glut”?

� “globalisation of markets”, including labour?

� Puzzles and the need to pull it all together!

Effective central bank policy?

� Central banks in industrial countries learned from the 1970s

� Central banks in emerging markets learned from the industrial countries (IT frameworks)

� But two puzzles remain:

(1) common outcome in spite of widely divergent national circumstances

(2) Low inflation in spite of exceptionally easy monetary policy

Real interest rates and credit growth

The “savings glut”?

� High savings rates outside the US have suppressed global demand and inflation

� But again puzzles remain:

(1) Global saving has not risen, though investment has fallen

(2) And global growth remains exceptionally high

Globalisation?

� Loss of pricing power

� But still high profits

� Wages take the hit

Loss of pricing power

But wages take the hit

Wage suppression

� Through diverse channels

(1) Immigration

(2) Import penetration

(3) Relocation and contestability

But again puzzles remain

� Globalisation cannot explain the rise of inflation in the 1970s

� Nor the long lag before EMEs were affected

� A more comprehensive explanation of the facts seems necessary

Pulling it all together?

� Recent low inflation needs to be explained

� But so too does record global growth

� And remarkably low interest rates

� The answer is, all of the above!

Consider a global model

� Aggregate supply increases

� As aggregate demand decreases

� And easy money fills the gap, globally

� Due to essentially fixed exchange rates

And finally the trade dimension

� Easy money has different effects in different countries

� The US and China as two extremes of

(1) Low savings (US) and high savings (China)

(2) Little (US) and massive (China) investment in tradables

Part 3: Prospects and exposures

� Will low inflation continue?

� Are “financial imbalances” a threat?

� Could deflation be the end game?

Will low global inflation continue?

� Are inflationary expectations more based on history than credibility?

� Is the global output gap declining?

� Does the US have special problems in ULC and the dollar?

Are financial imbalances” a threat?

� What is meant by financial imbalances?

� Sources of the problem?

� Evidence of imbalances today?

� Exposures?

What is meant by financial imbalances?

� Significant and sustained deviations from historical norms

� Such concepts play no part in the one period Keynesian model

� But cumulative processes were central to pre-War business cycle theory

Sources of the problem?

� Very low real interest rates

� Repeated use of asymmetric easing

� A more “elastic” credit system

� In sum, liquidity!

Evidence of imbalances today?

� High prices to buy all illiquid assets (bonds, spreads, equity, houses, art, stamps etc)

� Low prices to buy liquidity (implied volatility)

� Heavy debt levels of households

� Releveraging of corporations (LBOs, M&As)

� To say nothing of the trade imbalances

Exposures?

� 1 – 2 – 3 – 4

� If all financial imbalances have a single source, all could unwind together� If all financial imbalances have a single source, all could unwind together

� Better risk management will protect some, but not others

� Higher house prices do not increase national wealth

Could deflation be the end game?

� Global recession with initially stable prices

� Could lead to deflation

� Which might or might not be a problem

Part 4: Implications for policy regimes?

� History shows financial imbalances can pose serious problems

� If so, price stability is not enough!

� I believe we need a new macrofinancial stability regime

� But I must preach to a different audience

Thank you!Thank you!

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