Tuesday, April 24, 2007

Globalization and Monetary Policy

Macroblog has a post today titled "Does Globalization make Monetary Policy Harder?"

I think the answer is yes, but not because of the issues brought up on the article. On the site, I made the following comment:

I think the globalization impact on monetary policy has more to do with capital flows. Take for example Japan. It appears low interest rates in Japan have resulted in capital outflows without influencing consumer spending. Whether you are a monetarist or Keynesian, consumers have to spend more currency in order for prices to rise. If shifts in interest rates result in capital flows and not consumer activity, the ability to influence consumer prices is diminished.

In addition...

  • Globalization may be influencing wage levels more directly than goods prices. If wages don't grow (in nominal terms) you can't have inflation. In order for the aggregate price level to rise, consumers have to actually spend more. That requires either wages to rise or the savings rate to decline. If we agree that the savings rate will have a hard time declining in the U.S., we need wage growth to have inflation.
  • Rampant use of U.S. dollars for purposes other than U.S. consumption is influencing the U.S. money supply. I'm particularly thinking of flows from immigrants to foreign persons (i.e., sending dollars home that get spent in the foreign country), as well cash held to support dollar pegs.

Anyway, those are my thoughts. I think the net consequence of this is that monetary policy takes bigger swings than it did in the past, and that fighting deflation will be harder than fighting inflation.


Anonymous said...

Exceptionally interesting post.

My gut (yes, George, my gut) tells me we face a deflationary future.

You have said the world is awash in liquidity, but you are also saying it doesn't matter.

It's all very interesting.

Accrued Interest said...

The liquidity we are awash in seems to be limited to the capital markets. In theory, even if money was just printed non-stop for a year and dumped on the streets, and yet all that money was used to buy stocks, there would be no inflation. Other than the stock market. I mean, that's probably a simplification, and its obviously a non-sensical scenario, but you see my point.

That's what's happening in Japan in a way. So while I'm not worried about deflation now, if it comes up later, its going to tough to fight.

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