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Globalization and Monetary Policy :: May 13, 2008 :: Federal Reserve Bank of Cleveland home | news & media | careers | site map FEDERAL RESERVE BANK o f CLEVELAND A bout U Tours For the Public News & Media Com munit y D e velopm ent S tream ing Media Forefront M agazine Speakers Bureau I Our IRegion I Research I Ban kin g I Learning Center Savings Bonds Home > For th e Public > News and Media > Speeches > 2 0 08 > G lobalization and M onetary Policy Globalization and Monetary Policy Additional Information Introduction C e n tra l b a n k e rs s h a re a co m m o n re sp o n sib ility — k e e p in g th e p u rc h a sin g p o w e r o f o u r c u r re n c ie s s ta b le . O ver th e p a s t 3 0 y e a rs , p o lic y m a k ers a ro u n d th e w o rld h a v e c o m e to r e a liz e t h a t a low an d s ta b le r a te o f in fla tio n is in d is p e n s a b le fo r ac h ie v in g o th e r o b je c tiv e s , like m axim um s u s ta in a b le e c o n o m ic g ro w th , h e a lth y la b o r m a rk e ts , an d fin a n c ia l s ta b ility . As a p o lic y m a k e r, I fin d m y self in a c h a lle n g in g e n v iro n m e n t. In th e U n ited S ta te s , th e h e a d lin e C o n su m er P ric e Index, o r CPI, is rising a t 4%, an d th e c o r e CPI, w h ich ta k e s o u t fo o d a n d e n e rg y p ric e s, is rising a t 2.4% . Y et d e s p ite p ric e p re s s u re s , th e F e d e ra l R eserv e has c u t its f e d e r a l fu n d s r a t e ta r g e t by 3 2 5 b asis p o in ts s in c e la s t fa ll in re s p o n se to tu rm o il in fin a n c ia l m a rk e ts an d to h e a d o ff th e a s s o c ia te d d o w n sid e risks to e c o n o m ic g ro w th . T h e s u b s ta n tia l e a sin g o f m o n e ta ry policy to d a t e , c o m b in e d w ith ongo in g m e a s u re s to f o s te r m a rk e t liq u id ity , sh o u ld h e lp to p ro m o te g ro w th o v e r tim e an d to m itig a te risks to e c o n o m ic a c tiv ity . I know t h a t so m e o b s e rv e rs a r e say ing t h a t th is s tr a te g y in tro d u c e s o th e r risks. For e x a m p le , so m e in d iv id u als q u e s tio n w h e th e r by lo w erin g o u r po licy r a t e in th e fa c e o f p ric e p re s s u re s , w e p u t a t risk o u r goal o f k e e p in g in fla tio n low an d s ta b le o v e r th e long te rm . Sandra Pianalto P resident and CEO, Federal Reserve Bank o f Cleveland Global Interdependence Center (GIC) Abroad in Paris P aris, F ra n ce May 13, 2008 W hile e v e n th e c o r e p ric e m e a s u re s in th e U n ited S ta te s a r e rising s o m e w h a t f a s te r th a n I w o u ld p r e f e r , a n d in fla tio n p r e s e n ts a key risk to m y o u tlo o k , I b e lie v e t h a t th e F e d e ra l R e s e rv e ’s p o licy s tr a te g y re m a in s c o m p a tib le w ith a low an d s ta b le in fla tio n r a te . To b e t t e r u n d e rs ta n d th is s tr a te g y , I th in k i t is im p o r ta n t to d istin g u ish b e tw e e n th e c o n c e p t o f in fla tio n an d th e c o n c e p t o f r e la tiv e -p r ic e c h a n g e s . This d istin c tio n is e s p e c ia lly c r itic a l to d a y , w h e n r e la tiv e p ric e p re s s u re s a r e b o th g lo b a l a n d in te n s e . T o d ay, I w ill e x p la in how g lo b a l p ric e p re s s u re s c a n in c re a s e th e co m p le x ity o f fo rm u la tin g m o n e ta ry policy. I w ill b egin by d e s c rib in g th e tr a d itio n a l d e fin itio n o f in fla tio n . T h en , I w ill d iscu ss th e im p o r ta n t d istin c tio n b e tw e e n in fla tio n an d r e la tiv e p ric e p re ssu re s . F inally, I w ill d ra w on th is d istin c tio n to e x p la in w h y g lo b a liz a tio n has n o t c u r ta ile d th e a b ility o f m o n e ta ry p o lic y m a k ers to a c h ie v e p ric e s ta b ility . P le a se n o te t h a t th e v iew s I e x p re s s to d a y a r e m in e a lo n e a n d do n o t n e c e s sa rily r e f le c t th e v iew s o f my c o lle a g u e s in th e F e d e ra l R eserv e S y stem . Inflation L et m e beg in by d e fin in g a w o rd in th e e c o n o m is t’s lex ico n t h a t is o f te n m isu sed — in fla tio n . In fla tio n re f e r s to d e te r io r a tio n in th e p u rc h a sin g p o w e r o f m o n ey . It o c c u rs w h e n a c e n tr a l b a n k c r e a te s http://www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2008/Pianalto_20080513.cfm[4/29/2014 2:02:31 PM] Globalization and Monetary Policy :: May 13, 2008 :: Federal Reserve Bank of Cleveland m o re m o n e y th a n th e p u b lic w a n ts to h o ld . T he r e s u lt is an e v e n tu a l rise in all p ric e s a n d w a g e s. And as long as th is d is p a rity b e tw e e n th e su p p ly a n d d e m a n d fo r m o n e y p e rsis ts, p ric e s a n d w a g e s w ill k ee p rising. In fla tio n is alw ay s a h o m e -g ro w n , m o n e ta ry p h e n o m e n o n t h a t is u ltim a te ly u n d e r th e c o n tro l o f a c e n tr a l b an k . How quickly in fla tio n a ry im p u lses f ilte r th ro u g h to w a g e s a n d p ric e s, h o w ev e r, d e p e n d s on m an y th in g s—m o st im p o rta n tly , on th e s t a t e o f in fla tio n e x p e c ta tio n s a n d on th e d e g r e e o f sla c k in an ec o n o m y . W hen th e p u b lic g e n e ra lly a n tic ip a te s in fla tio n a n d w h e n an e c o n o m y is o p e r a tin g a t fu ll c a p a c ity , m o n e ta ry e x c e s s e s c a n q u ick ly tr a n s la te in to h ig h e r p ric e s a n d w a g e s. G lo b a liz a tio n c a n e x a c e r b a te th e in fla tio n p ro c e ss o n ly if it so m e h o w im p a irs c e n tr a l b a n k o p e r a tio n s , b u t th is se e m s u n lik ely . In f a c t, s o m e sc h o la rs b e lie v e t h a t g lo b a liz a tio n has a c tu a lly im p ro v e d th e b e h a v io r o f c e n tr a l b an k s by p e n a liz in g th o s e w h o se c u r re n c ie s la ck a s ta b le p u rc h a sin g p o w e r. T h e se sc h o la rs c o n te n d t h a t g lo b al c o m p e titio n a n d th e f r e e flo w o f fin a n c ia l fu n d s h a v e e n c o u ra g e d g o v e rn m e n ts to e s ta b lis h in d e p e n d e n t, tr a n s p a r e n t c e n tr a l b an k s an d to a c c e p t m o re e x c h a n g e - r a te fle x ib ility . In d e e d , w o rld in fla tio n m o d e ra te d d u rin g th e 1 9 9 0 s as th e g lo b al in te g r a tio n o f fin a n c ia l m a rk e ts a c c e le r a te d . From th e e a rly 1 9 7 0 s to th e e a rly 1 9 9 0 s , fo r e x a m p le , w o rld in fla tio n a v e ra g e d a ro u n d 16 p e r c e n t p e r y e a r , a c c o rd in g to th e In te rn a tio n a l M o n e tary Fund. Since th e m id -1 9 9 0 s , w o rld in fla tio n has a v e ra g e d slig h tly less th a n 5 p e r c e n t. M ost o f th e r e c e n t im p ro v e m e n t has c o m e fro m d ev e lo p in g an d e m e rg in g m a rk e t e c o n o m ie s —g ro u p s t h a t p rev io u sly la ck e d m o n e ta ry -p o lic y d isc ip lin e . By th e m id -1 9 8 0 s , c e n tr a l b an k s in key d e v e lo p e d c o u n trie s —n o ta b ly th e U n ited S ta te s , E ngland, J a p a n , an d m an y E u ro p e an c o u n trie s —re g a in e d m uch o f th e c re d ib ility t h a t th e y h ad lo st in th e 1 9 7 0 s . In th e s e c o u n trie s , re s id e n ts b e n e f it b o th from th e d ir e c t e f f e c ts o f low a n d s ta b le in fla tio n , an d th e in d ir e c t e f f e c ts o f h aving a c u rre n c y w ith in te r n a tio n a l- r e s e r v e s ta tu s . From th is p e rs p e c tiv e , I do n o t b e lie v e t h a t g lo b a liz a tio n p re v e n ts a c e n tr a l b a n k fro m ac h ie v in g its in fla tio n o b je c tiv e . Relative-Price Changes O f c o u rse , p ric e s c a n c h a n g e fo r re a so n s o th e r th a n in fla tio n . In d ividual p ric e s c o n tin u a lly a d ju s t to ch a n g in g su p p ly a n d d e m a n d p re s s u re s . E conom ists r e f e r to th e s e as relative-price a d ju s tm e n ts , an d th e y a r e f u n d a m e n ta lly d if f e r e n t fro m in fla tio n . R e la tiv e -p ric e c h a n g e s co n v e y im p o r ta n t in fo rm a tio n a b o u t th e s c a rc ity o f p a r tic u la r goods a n d se rv ic e s . A rising re la tiv e p ric e in d ic a te s t h a t d e m a n d is o u ts trip p in g su p p ly (o r t h a t su p p ly is fallin g b e h in d d e m a n d ), w h ile a fa llin g r e la tiv e p ric e in d ic a te s j u s t th e o p p o s ite . A lthough r e la tiv e - p r ic e c h a n g e s c a n b e q u ite u n c o m fo rta b le fo r c o n s u m e rs, th e y tr a n s m it v ita l in fo rm a tio n n e e d e d fo r th e e f f ic ie n t a llo c a tio n o f re s o u rc e s th ro u g h o u t an y m a rk e t e c o n o m y . W hen th e r e la tiv e p ric e o f a p a r tic u la r good rises, c o n s u m e rs te n d to c o n s e rv e on t h a t good an d look fo r s u b s titu te s . P ro d u c e rs r e a c t to a rising re la tiv e p ric e by b ringing m o re o f th e good to m a rk e t in h o p es o f b o o stin g p ro fits. In fla tio n , by c o n tr a s t, c o n trib u te s no in fo rm a tio n u se fu l to o u r c o n s u m p tio n , p ro d u c tio n , a n d la b o r c h o ic e s. If an y th in g , in fla tio n can a d d n o ise to th e p ric e sig n als t h a t inform o u r d e c isio n s a n d m ay le a d p e o p le to m a k e u n so u n d e c o n o m ic c h o ic e s. Even w o rs e , in fla tio n can c a u s e p e o p le to s h ift tim e an d re s o u rc e s aw a y fro m a c tiv itie s t h a t f o s te r p ro d u c tio n a n d lo n g -te rm e c o n o m ic g ro w th a n d to w a rd a c tiv itie s t h a t s e rv e o nly to p r o te c t th e ir w e a lth , r a th e r th a n to e x p a n d it. http://www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2008/Pianalto_20080513.cfm[4/29/2014 2:02:31 PM] Globalization and Monetary Policy :: May 13, 2008 :: Federal Reserve Bank of Cleveland G lo b a liz a tio n d o e s n o t im p a ir a c e n tr a l b a n k ’s a b ility to c o n tro l in fla tio n , b u t — as r e c e n t e v e n ts d e m o n s tr a te — i t c a n so m e tim e s m agnify r e la tiv e - p r ic e c h a n g e s by ex p o sin g in d iv id u al c o u n trie s m o re in te n s e ly to g lo b a l d e m a n d a n d su p p ly p re s s u re s . S om e o f th e s e a f f e c t c o n s u m e rs ’ p o c k e tb o o k s d ire c tly , as th ro u g h th e p ric e s o f im p o rte d a n d e x p o r te d go o d s. O th e rs, o f c o u rs e , a r e less d ir e c t. A lo t o f d o m e s tic p ro d u c tio n u ses fo re ig n in p u ts , so d o m e s tic c o s ts c a n rise an d fa ll w ith g lo b a l p ric e sh o ck s. S im ilarly, fo re ig n c o m p e titio n w ill a f f e c t th e p ricin g s tr a te g y o f d o m e s tic firm s a n d th e w a g e d e m a n d s o f d o m e s tic la b o r o rg a n iz a tio n s. S om e o f th e o th e r b e n e fic ia l e f f e c ts o f g lo b a liz a tio n a r e e v e n h a r d e r to s e e . By fo s te rin g sp e c ia liz a tio n an d te c h n o lo g y tr a n s f e rs , g lo b a l m a rk e t in te g r a tio n slow ly im p ro v es p ro d u c tiv ity a n d lo w ers u n it c o s ts , th e r e b y su p p o rtin g lo w e r in fla tio n . A t tim e s , h o w e v e r, d e v e lo p m e n ts in w o rld m a rk e ts c a n c r e a t e o b s ta c le s fo r c e n tr a l b an k s. P e tro le u m , a g ric u ltu ra l g o o d s, an d m any o th e r c o m m o d itie s a r e now e x p e rie n c in g s tro n g u p w ard r e la tiv e -p r ic e p re s s u re s . Tw o f a c to rs se e m to a c c o u n t fo r m o st o f th is . F irs t, th e w o rld h as e x p e r ie n c e d n e a rly u n p r e c e d e n te d e c o n o m ic p e rfo rm a n c e in r e c e n t y e a rs . B e tw e e n 2 0 0 4 an d 2 0 0 7 , w o rld o u tp u t e x p a n d e d a t a 4 . 8 p e r c e n t a v e ra g e a n n u a l r a te . W hile e m e rg in g m a rk e ts in Asia, n o ta b ly C h in a a n d In d ia, a p p e a r to h a v e le d th e w ay , n e a rly e v e ry n a tio n on e a r th s h a re d in th e e x p a n sio n . T his g ro w th an d d e v e lo p m e n t, h o w e v e r, has p la c e d g r e a te r d e m a n d s on w o rld re s o u rc e s , le a d in g to s h a rp in c re a s e s in re la tiv e p ric e s. S in ce 2 0 0 2 , th e p ric e o f fo o d im p o rte d in to th e U n ites S ta te s has in c re a s e d a t an a v e ra g e a n n u a l r a t e n e a rly 4 p e r c e n t f a s te r th a n th e CPI, a n d th e p ric e o f im p o rte d in d u s tria l c o m m o d itie s has in c re a s e d a t an a v e ra g e a n n u a l r a te 15 p e r c e n t f a s te r th a n th e CPI. T h e se c o n d f a c to r p u ttin g u p w a rd p re s s u re on re la tiv e c o m m o d ity p ric e s is th e d o lla r ’s d e p r e c ia tio n . S ince e a rly 2 0 0 2 , th e d o lla r has fa lle n a t a 5 p e r c e n t a v e ra g e a n n u a l r a te on a b ro a d , tr a d e -w e ig h te d b asis. A d o lla r d e p r e c ia tio n ra ise s th e d o lla r p ric e o f goo d s t h a t U.S. re s id e n ts im p o rt. It also lo w ers th e f o re ig n -c u rre n c y p ric e o f all d o lla r-d e n o m in a te d goods, w h e th e r th e y a r e p ro d u c e d in th e U nited S ta te s o r a b ro a d . In th is w ay , a d o lla r d e p r e c ia tio n sh ifts w o rld d e m a n d to w a rd all goods d e n o m in a te d in d o lla rs, w h ich th e n raise s th e r e la tiv e d o lla r p ric e o f all su ch tr a d e d goods. R e la tiv e -p ric e p re ssu re s c a n b e fa irly b r o a d - b a s e d . Oil and a g ric u ltu ra l p ro d u c ts e n t e r th e p ro d u c tio n p ro c e s se s o f a w id e ra n g e o f o th e r goods, fro m p la stic s to p ro c e sse d fo o d s. R e la tiv e -p ric e p re ssu re s c a n also b e p e r s is te n t. Oil p ric e s h av e r a tc h e te d up o v e r th e p a s t n in e y e a rs an d th e d o lla r has d e p r e c ia te d fo r m o re th a n six y e a rs . N e v e rth e le s s, as long as a c e n tr a l b a n k is n o t c r e a tin g an ex c e s siv e a m o u n t o f m o n ey , th e s e re la tiv e p ric e p re s s u re s o u g h t to b e tr a n s ito ry . As c o n s u m e rs sp e n d m o re m o n e y fo r h ig h e r-p ric e d p e tro le u m an d a g ric u ltu ra l goods, th e y e v e n tu a lly h a v e less m o n ey to sp e n d on o th e r goods a n d se rv ic e s . O th e r r e la tiv e p ric e s m u s t th e n fa ll. E v en tu ally , th e a v e ra g e r a t e a t w h ich p ric e s c h a n g e w ill b e th e in fla tio n r a te as d e te r m in e d by th e c e n tr a l b an k . Now, c le a rly , if p e o p le s p e n d m o re on n e c e s s itie s su ch as h ig h erp ric e d e n e rg y a n d a g ric u ltu ra l goods, th e ir o v e ra ll c o s t o f living w ill rise . If th e y do n o t also p ro d u c e a n d se ll th e s e s a m e c o m m o d itie s — as is ty p ic a lly th e c a s e — th e ir s ta n d a r d s o f living w ill fa ll, t h a t is, th e ir in c o m es w ill buy less. In d e e d , w e h a v e r e c e n tly w itn e s s e d food rio ts in so m e d e v e lo p in g c o u n trie s . W hile s o m e tim e s d e v a s ta tin g , th e s e g lo b a l r e la tiv e - p r ic e p re s s u re s a r e n o t th e s a m e th in g as in fla tio n . Central Banks in a Global Economy I h av e d raw n a s u b tle , b u t im p o r ta n t d istin c tio n b e tw e e n re la tiv e - http://www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2008/Pianalto_20080513.cfm[4/29/2014 2:02:31 PM] Globalization and Monetary Policy :: May 13, 2008 :: Federal Reserve Bank of Cleveland p ric e p re s s u re s a n d in fla tio n . C e n tra l b anks c a n n o t do a n y th in g a b o u t r e la tiv e p ric e s. W e do n o t p ro d u c e o il, w h e a t, ric e , o r a n y o th e r c o m m o d itie s. B u t th ro u g h o u r m o n e ta r y policy a c tio n s , w e c a n c r e a te o r p r e v e n t in fla tio n . G lo b a liz a tio n has n o t f u n d a m e n ta lly im p a ire d o u r a b ility to p ro v id e lo n g -te rm p ric e s ta b ility , b u t i t c o m p lic a te s m o n e ta ry policy in a t le a s t tw o key w ays. F irst, g lo b a l re la tiv e p ric e sh ocks c a n o b s c u re a p o lic y m a k e r’s a b ility to i n te r p r e t p ric e s ta tis tic s , m aking it h a r d e r to d istin g u ish b e tw e e n te m p o r a r y r e la tiv e - p r ic e c h a n g e s an d in fla tio n tr e n d s . W e find o u rse lv e s n e e d in g to a n a ly z e such th in g s as th e u n d erly in g n a tu r e of fo re ig n d is tu rb a n c e s , o r th e p e r s is te n c e o f e x c h a n g e - r a te c h a n g e s , o r th e d e g r e e o f p a s s-th ro u g h to im p o rt p ric e s, o r th e re sp o n se of d o m e s tic c o m p e tito rs . Sim ply p u t, g lo b a liz a tio n re q u ire s us to e x p a n d th e a m o u n t o f in fo rm a tio n w e c o n s id e r in o u r p o lic y -m ak in g p ro ce ss. S eco n d , o u r a b ility to a c c u r a te ly i n te r p r e t p ric e s ta tis tic s a f f e c ts o u r a b ility to c o m m u n ic a te e f f e c tiv e ly w ith th e p u b lic . E ffe ctiv e c o m m u n ic a tio n h elp s us a n c h o r in fla tio n e x p e c ta tio n s . L apses in o u r a b ility to co n v e y a c c u r a te an d tim e ly in fo rm a tio n a b o u t th e u n d erly in g n a tu r e o f p ric e c h a n g e s c a n c r e a t e u n c e r ta in tie s a b o u t c e n tr a l b a n k o b je c tiv e s , d a m a g e o u r c re d ib ility , a n d im p o s e c o s ts on th e ec o n o m y . B ut, as I h av e sa id th r o u g h o u t my ta lk to d a y , g lo b a liz a tio n c o m p lic a te s o u r task; it d o e s n o t p r e v e n t us fro m ac h ie v in g o u r goals. Conclusion I h o p e t h a t my re m a rk s h av e f u r th e r c la rifie d th e s u b tle , b u t v e ry im p o r ta n t, d if fe r e n c e b e tw e e n r e la tiv e - p r ic e p re s su re s a n d in fla tio n . I b e lie v e t h a t th e d if fe r e n c e h in g es on a d istin c tio n b e tw e e n re la tiv e p ric e c h a n g e s , w h ich c e n tr a l banks c a n do n o th in g a b o u t, an d in fla tio n , w h ich c e n tr a l banks c o n tro l. As I o u tlin e d , g lo b a liz a tio n has in c re a s e d th e c o m p le x ity of d istin g u ish in g b e tw e e n r e la tiv e - p r ic e c h a n g e s a n d in fla tio n , b u t I do n o t b e lie v e t h a t g lo b a liz a tio n has f u n d a m e n ta lly c u r ta ile d th e a b ility o f c e n tr a l banks to a c h ie v e th e ir in fla tio n o b je c tiv e s . Careers | Diversity | Privacy | Terms of Use | Contact Us | Feedback | RSS Feeds http://www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2008/Pianalto_20080513.cfm[4/29/2014 2:02:31 PM]
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