Download Globalisation, import prices and inflation targeting

Central Bank of Iceland – International Monetary Fund
The Challenges of Globalisation for Small Open Economies with
Independent Currencies
31 May – 1 June, Reykjavik
Globalisation, import prices and
inflation targeting
Alex Bowen,
Senior Policy Fellow,
Bank of England
Globalisation is…
• “…a hideous word of obscure meaning…”
• “a movement in the direction of greater integration, as
both natural and manmade barriers to international
economic exchange continue to fall”
(Martin Wolf (2004))
Falls in transport costs
Source: OECD Economic Outlook No 81 (forthcoming)
Falls in costs of processing information
Source: OECD Economic Outlook No 81 (forthcoming)
Falls in tariffs
Source: OECD Economic Outlook No 81 (forthcoming)
IMF export-weighted measure of
global labour supply
Source: IMF
Global demand
Global GDP
Per cent
Euro Area
US
China
Non-China Asia
Rest of World
World
6
5
4
3
2
1
0
1980
1985
1990
Source: Thomson Datastream
1995
2000
-1
2005
Imports from low-cost economies
Source: IMF
Central banks’ interest
• “the emergence of China, India, and the former
communist-bloc countries implies that the greater part
of the earth's population is now engaged, at least
potentially, in the global economy. There are no
historical antecedents for this development.”
(Bernanke, 2006)
• “the integration of China, India and other emerging
market economies into the world economy… [is] a
process that has transformed supply and demand
conditions across the globe.” (King, 2006)
Central banks’ interest
• “Have Tesco, Dixon’s and China done more to keep inflation
down than the Bank economists?” (City AM, London, 21
May)
• “The globalisation dividend over the past decade, as cheap
goods from China pushed down prices, is fading” (Daily
Telegraph, London, 16 May)
• “China makes lots of cheap goods… the imports help keep US
inflation down” (The Business, London, 21 April)
• “For years, British consumers… have taken for granted ‘the
China effect’ – the downward pressure on inflation that comes
from importing cheap goods from the workshop of the world”
(The Guardian, London, 18 April)
How might globalisation affect
inflation?
• Raising the consumption wage relative to the
product wage: favourable ‘tailwinds’
– Depends on how wage bargainers respond in pay
bargaining and consumption
• Changing short-run inflation dynamics
– Product market competition
– Labour market competition
– Role of global vs. national indicators of slack
UK Phillips Curve
RPIX Inflation %
30
1970s
25
20
1980s
1990 to
present
Unemployment
rate %
0
2
Source: Bank of England
4
15
10
5
0
6
8
10
12
14
‘Globalisation and inflation in the
OECD economies’ (Pain, Koske and
Sollie (2006))
• Imports from low-cost countries have
contributed to lower domestic inflation
– Direct accounting effect
– Lower-cost imports have put pressure on domestic
producers to lower prices in import-competing
industries
• Domestic inflation less sensitive to measures
of domestic economic slack, more sensitive to
measures of foreign economic slack
Can central banks rely on China and
India to do their work for them?
• No
– Trade theory: once countries have emerged from
autarky, the sign of the impact of globalisation on
the terms of trade of developed countries is
ambiguous
– Empirics: the impact on inflation in an accounting
sense may not be large, and may sometimes add to
inflation
– The impact on domestic inflation of an
improvement in the terms of trade depends on the
policy reaction
What is the impact of globalisation
on the terms of trade?
• Consider a steady increase in the size of the industrial labour
force in China
• Ricardian model: industrial countries’ terms of trade improve
(export prices up relative to import prices)
• Heckscher-Ohlin model, no transport costs: impact on terms
of trade cushioned by increase in labour intensity in all
industries, increased specialisation
• ‘North-South’ models: depends on the model. In Dinopoulos
and Segerstrom (2006), for example, the North’s terms of trade
deteriorate as the Southern labour force increases
• Exhaustible natural resource pricing: impact on expected
future path of demand and real interest rates important; price
increases not due only to short-run supply constraints
Emerging market economies’
contribution to world consumption of
commodities (2002-2005)
Aluminium
Copper
Lead
Nickel
Steel
Tin
Zinc
Oil
World Consumption
Growth, Annual
Average %
Contribution of
Leading EM E's to
world consumption
growth (%)
7.6
3.8
4.3
3.6
9.2
8.1
3.8
2.2
57
92
103
76
62
88
120
37
Source: WEO Autumn 2006 and IEAD calculations
‘Leading EMEs’ = China, Brazil, India, Mexico and Russia
o/w China (pp)
48
51
110
87
54
86
113
30
Cumulative Price
Increase (%)
41
136
116
118
n/a
82
78
118
UK terms of trade
1995=100
120
110
100
90
80
Goods and services
Goods
70
Services
60
1955
Source ONS
1962
1969
1976
1983
1990
1997
2004
Price levels for UK manufacturing
goods imports
weighted unit value, £
20
18
16
14
NMS
China
High Cost
ROW
T ot al
12
10
8
6
4
2
1999
2000
Source: ONS and Bank of England
2001
2002
2003
2004
2005
0
2006
Annual import price inflation
Low Cost Share Effect
Low Cost Price Effect
High Cost Inflation Effect
Import Price Inflation
oya %
6
4
2
0
-2
-4
-6
2000
2001
Source: ONS and Bank of England
2002
2003
2004
2005
-8
2006
‘Has globalisation changed inflation?’
(Ball (2006), NBER WP 12687)
• ‘Has globalization reduced the long-run level
of inflation?’
• ‘Has it affected the structure of inflation
dynamics, as summarized by the Phillips
Curve?’
• ‘Has it contributed substantial negative shocks
to the inflation process?’
‘Has globalisation changed inflation?’
(Ball (2006), NBER WP 12687)
• ‘Has globalization reduced the long-run level
of inflation?’ No
• ‘Has it affected the structure of inflation
dynamics, as summarized by the Phillips
Curve?’ No
• ‘Has it contributed substantial negative shocks
to the inflation process?’ No
Inflation in industrial countries
per cent
35
30
25
20
15
United Kingdom
10
5
0
Q1 1962
Q1 1972
Source: Bank of England
Q1 1982
Q1 1992
Q1 2002
-5
Goods and services inflation
Per cent
Services
6.0
5.0
4.0
3.0
CPI
2.0
1.0
0.0
-1.0
Goods
-2.0
-3.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: ONS
Conclusions
• Globalisation a hugely important
phenomenon…
• …but not primarily a monetary one
• It could have a significant impact on short-run
inflation dynamics in developed open
economies…
• …but the evidence is not clear-cut
• Monetary policy, not relative import prices, is
the key determinant of domestic inflation
Further work needed
• Defining terms: what is globalisation?
• Integrating trade theory and open-economy
macroeconomics better
• What determines emerging-market export
prices?
• Estimation and testing of structural models of
inflation with an explicit foreign sector and
policy function