Earlier this week BIS, the Bank of International Settlements, held ita Annual General Meeting and published its Annual Report. In my opinion this is the best single source on inflation and monetary policy and is required reading for all central bank watchers. This year, there is also an illuminating analysis on how globalisation has affected wages and prices. Here is the report's contents:
76th Annual Report by chapter: Table of contents, letter of transmittal Read (PDF, 11 pages, 53 kb) I. Introduction: resilience to mounting strains Abstract | Full Text (PDF, 8 pages, 56 kb) II. The global economy Abstract | Full Text (PDF, 23 pages, 819 kb) III. Issues in emerging market economies Abstract | Full Text (PDF, 25 pages, 800 kb) IV. Monetary policy in the advanced industrial economies Abstract | Full Text (PDF, 20 pages, 1842 kb) V. Foreign exchange markets Abstract | Full Text (PDF, 19 pages, 1472 kb) VI. Financial markets Abstract | Full Text (PDF, 22 pages, 1487 kb) VII. The financial sector Abstract | Full Text (PDF, 20 pages, 593 kb) VIII. Conclusion: coping with risks, today and tomorrow Abstract | Full Text (PDF, 14 pages, 67 kb) Organisation, governance and activities of the Bank Abstract | Full Text (PDF, 74 pages, 326 kb)
Over the fold I have includede several press reports highlighting BIS' warnings about inflation, the need for higher rates, and the impact of globalisation. But you are much better off reading the report yourself.
Central bankers under fire over globalisation, by Chris Giles, FT Economics Editor:
Business leaders and central bankers have been the traditional defenders of globalisation, so when the Bank for International Settlements, the central banker’s banker, says that the main risks to the global economy stem from globalisation, central banks take notice.
The BIS annual report, of course, is much more nuanced than to suggest the twin threats of inflation and slow growth are the simple result of the process of globalisation. Rather, the threats might have been caused by central banks’ inadequate response to the new challenges of globalisation, according to the BIS report .
It starts from the fact that global inflation fell in advanced economies in the mid-1980s and has remained low and stable since. The BIS provides five reasons why globalisation helped central banks reduce inflation and keep it low.
First, by opening markets to cheap imported goods, globalisation reduced the costs of bringing high inflation down; a deep recession and surging unemployment was no longer the flip-side of domestic price restraint.
Second, globalisation prevented countries and businesses being beholden to a small number of suppliers so they could shop around if these prices rose. Third, money flowed to successful countries, sharpening the incentives faced by policymakers.
Fourth, falling import prices allowed central bankers to tolerate very low inflation rates which previously had been associated with the perils of deflation. Fifth, by bringing down inflation quickly, globalisation added to the credibility of central bankers.
The trouble was, the BIS report adds, those benefits came at the price of distorting “the traditional guideposts of monetary policy”. Estimates of slack in the economy no longer provided a reliable guide to inflationary pressure bubbling away; and low inflation and interest rates pushed asset prices to unprecedented levels.
The BIS worries that inflationary pressures are now becoming more apparent after three years of rapid world economic growth. Energy prices are high and rising, and imported goods prices into advanced economies are no longer falling.
But inflation is not the only current risk, the BIS says. Global trade imbalances have also emerged as a result of globalisation, the ultra-loose monetary policy in the US and Chinese unwillingness to let their currency appreciate.
The BIS recommends “the current phase of monetary tightening seems clearly justified”, but it warns “the issue of how higher rates and financial imbalances might interact needs careful consideration”.
The report provides little hope of an easy resolution should the risks materialise, but it does recommend that monetary policy, in future, should look further ahead than the usual two to three year policy horizon so that policy-makers can seek to avoid building up such big imbalances.
Ashley Seager in the Guardian writes that central banking forum says rates may have to rise further:
Central banks around the world may need to raise interest rates further to ensure that inflation remains under control, the Bank for International Settlements warned yesterday. The Federal Reserve and the European Central Bank have been raising rates for some time but there is growing concern in financial markets that the threat of inflation has not yet been curbed as the booming world economy raises the price of oil and other commodities.
Releasing its annual report, the Basle-based organisation of central banks said it shared those worries as well as rising unease over imbalances in the world economy stemming from the large US current account deficit and China's growing trade surplus.
Malcolm Knight, BIS's general manager, said: "To achieve and to continue to achieve low and stable inflation, central banks do need to bring real interest rates back into positive territory. "That already has been done in some countries, notably the United States. But the decision on what pace to do that at and how far to go will depend very much on the incoming data."
The BIS stated: "Global trade imbalances have also emerged as a result of globalisation, the ultra-loose monetary policy in the US." I find it interesting that international organizations, e.g. the BIS, IMF, and World Bank, have blamed the U.S. for other countries poor economic policies. The aggressiveness of export-led growth by many U.S. trading partners is the root of the global economic imbalance. These export countries buy U.S. Treasury Bonds to keep their currencies weak to continue exporting. Consequently, U.S. market interest rates remain low. Currently, the U.S. 10-year T-Bond yield is below the Fed Funds Rate. Moreover, The U.S. Trade Balance in 2006 will be negative $800 billion. So, how can these organizations fault the U.S. Federal Reserve? U.S. fiscal policy could be blamed. The Bush Admininstration cut taxes in 2001 to 2003 and continues to maintain those tax cuts. Perhaps, the Bush Administration should have raised taxes after the 2001 recession, and subsequent period of slow growth, perhaps after the 2004 election. However, that would have reduced the benefits to U.S. consumers and some of the benefits to U.S. producers. The correcting mechanism is for export-led economies to accept higher unemployment and lower output. Unfortunately, that correction is increasingly shaping up to take place unwillingly, suddenly, and sharply.
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