IMF: How has globalisation affected inflation?

A fascinating new IMF analysis of the impact of globalisation on inflation has just been published as Chapter 3 of the latest World Economic Outlook. This chapter, How Has Globalization Affected Inflation? (PDF), provides "robust support for the global competition hypothesis", with greater trade integration and foreign competition seeing falling import prices. There have also been greater restraints on domestic price and wage growth in sectors more exposed to international competition, such as textiles and electronics. However "the direct effect of globalization on inflation through import prices has in general been small in the industrial economies".

That said, when global spare capacity increases—such as during the 1997–98 Asian financial crises and the 2001–02 global slowdown—import price declines have had sizable effects on inflation over one- to two-year periods, shaving more than 1 percentage point off actual inflation in some advanced economies.

The authors also conclude that "the risks of ongoing deflation due to globalization ...generally seem small, especially at the current juncture". But the large falls in import prices during periods of global spare capacity "lends support to the view that inflation targets should not be set too close to zero—otherwise shocks of this size could result in periods of deflation".

IMF staff estimate that on average globalisation has reduced inflation through the channel of non-oil import prices by around ¼ percentage point a year in the advanced economies, with a larger effect of ½ percentage point a year in the US. But, as noted, these import effects are neither regular nor persistent, and so cannot be relied upon to prevent higher inflation in the period ahead. Globalisation is "no guarantee of low inflation over the next year or two", as "robust global growth and diminishing economic slack have reduced the restraining impact of declining import prices on inflation."

..in the short term, there are both upside and downside risks to the inflation impact of globalization. the possible upside risks are reinforced by the recent increases in commodity prices, which have been associated with the very same force that has put pressure on prices of manufactures, namely the rising integration of major emerging market economies into the world trade system.

Though it is inconclusive as to whether globalisation has contributed to the rise in the the gross operating surplus, the IMF analysis does lend some support to the 'global labour arbitrage' thesis:

Overall, therefore, the empirical evidence appears to support the proposition that the moderating effects of globalization on domestic producer prices are restraining unit labor costs and labor compensation. In addition, a fall in relative unit intermediate costs appears to have played some role in explaining the faster decline in relative prices in manufacturing. This could reflect outsourcing, which, in turn, could in part explain the behavior of unit labor costs.

Another key conclusion is that monetary policy still matters.

Over the medium term, the prevailing nominal anchor—such as the central bank’s inflation target—determines inflation. Therefore, the impact of globalization on inflation will be temporary unless it changes the overarching objectives of monetary policy. This is unlikely in industrial countries given the already low single-digit inflation targets (explicit or implicit).

But central bankers will find they need to recognise the growing importance for monetary policy of global spare capacity, and the somewhat diminished role of domestic output gaps. The global output gap is a topic that HSBC economist Janet Henry has recently examined. So too have BIS researchers Claudio Borio and Andrew Filardo, according to a recent post by Stephen Roach.*

*Claudio Borio and Andrew Filardo, “Globalisation and inflation: New cross-country evidence on the global determinants of domestic inflation,” BIS work in progress, March 2006 (I have been unable to find this paper online)

UPDATE: Soundbites and a webcast with Thomas Helbling, IMF Deputy Division Chief are now available online. So too is the transcript from yesterday's WEO launch. Raghu Rajan, IMF Economic Counselor and Director of Research, summarised the chapter's findings thus:

Chapter III, entitled "How has Globalization Affected Inflation?" finds that globalization has held down inflation in the past decade in a number of ways. Most people think of globalization reducing inflation by reducing the price of imported goods. This has been important at times. ...But in normal times, it is not as important as most people think. In fact, at this point, because of higher oil and commodities prices, imports are adding to headline inflation in most industrial countries.

Other channels through which globalization works have been more important and perhaps more consistently present. First, globalization may lower the inflationary response to domestic capacity constraints. Put another way, a sudden expansion in demand for goods now translates into higher imports rather than into higher prices, since in an integrated world, domestic supply constraints do not matter as much. This is partly why the U.S. can consume 7 percent more of its GDP than it produces without serious inflation.

Second, foreign competition has constrained wage increases in industries most open to global competition, and even lowered the sensitivity of wages to productivity increases. Of course, this does not mean globalization necessarily lowers wages, because it also spurs productivity growth itself. Nevertheless, the effect of globalization on wages will become an increasingly debated issue, especially as the share of labor income in total output of developed countries continues to fall.

The chapter concludes that despite being helpful in the past, globalization may not continue to be a crutch for central bankers to lean on. Spare capacity is decreasing worldwide, and tight domestic labor markets can also attenuate the effects of global competition on wages. Central bankers must, therefore, be prepared for their jobs to become more difficult in the period ahead.

Comments

[Edward Hugh]

"provides "robust support for the global competition hypothesis""

This has been being argued by Rogoff for some time now. I agree with him. This is why the inflation targeting and good housekeeping at the central bank is way too simple. It matters, at least some version of it matters (I'm not a wholehearted IT fan), but its a long, long way from being the whole story.

"the risks of ongoing deflation due to globalization ...generally seem small, especially at the current juncture"

Small at this juncture, but what about at the next one?

"these import effects are neither regular nor persistent, and so cannot be relied upon to prevent higher inflation in the period ahead."

Nor, simply applying the same argument, can they be relied on to prevent deflation in the period after that. Volatility means what it says.

"So too have BIS researchers Claudio Borio and Andrew Filardo"

Borrio has been arguing about the dangers of Irving Fisher style debt deflation ever since the Nasdaq crash. That is why he has been popular with Roach. They are both pretty 'Austrian'.

"The global output gap" is an interesting idea. I go along with Dallas Fed President Richard Fisher's argument that in a globalised world the idea of a national output gap is less and less relevant, but globally the idea makes much more sense. This also fits in with Andy Xie's methodological proposal that in macro terms we stop thinking about the global economy as an agglomeration of individual partially-open economies, and instead consider it one single 'developing economy' with a lot of regional market imperfections (home bias etc). Personally I find this idea makes a lot more sense.

You can find a good example of Fisher's speeches here:

http://www.dallasfed.org/news/speeches/fisher/2006/fs060404.html

[Tapsearch Com Editor]

For a good real world resource for any study on Globalization, Free Trade and Workers Dignity, see Tapart News and Art that Talks at http://tapsearch.com/tapartnews.
The editor and artist is Ray Tapajna who also evaluates The World is Flat by New York Times writer Thomas Friedman based on real world experiences from the streets of USA as things actually are.
Many are missing in action from any kind of real reporting as exposed in New Orleans after Hurricane Katrina. A Silent Depression resides in the USA. Only about 38% of all workers in the USA qualify for unemployment insurance. See http://tapsearch.com/flatworld/
See also "if you are not part of any network, you do not exist" at http://www.experiencedesignernetwork.com/archives/000636.html