Tuesday, April 24, 2007

Globalization and Inflation

The other day I was discussing with a friend wondering whether Globalization has any effect on inflation.

I just did some reading on that topic and the summary so far is that globalization should lead to lower inflation but so far empirical evidence shows negligible impact.

There are a number of ways in which globalization could effect prices in an economy and Janet Yellen provides a very good summary of the same. She also points to two studies both showing very little impact of globalization on inflation:

  • IMF analysis estimates for a panel of eight industrial countries, including the U.S. The study finds that the slower rise in relative import prices in recent years has had only a fairly small impact on overall inflation. For the U.S., the study estimates that a 1 percent decline in relative import prices lowers CPI inflation by only 15 basis points after one year and 6 basis points after three years. Based on such estimates, the IMF calculates that non-oil import price reductions lowered U.S. inflation by an average of ½ percentage point a year over 1997 to 2005.
  • Federal Reserve Board study estimates that lower (core) import prices have reduced core U.S. inflation by an annual average of ½ to 1 percentage.

Krozner and Bernanke have also given very insightful speeches on the above.

Ken Rogoff has taken a step further. He says Chinese exports lower relative prices and as long as Central Bank targets the overall price level, the prices of the other goods must actually be rising. Hence, China could actually be exporting inflation and not deflation as is the common perception.Theoretically it appears quite good, but has to be still tested empirically. ( Atleast I am not aware of papers on this)

There have been further papers by Laurence Ball and John Taylor (the person who gave the famous Taylor formula that gives interest rates given the inflation conditions). These papers also suggest that Globalization has not changed inflation. Read this abstract from Ball paper:

" Many observers suggest that the "globalization" of the U.S. economy has changed the behavior of inflation. This essay examines this idea, focusing on several questions: (1) Has globalization reduced the long-run level of inflation? (2) Has it affected the structure of inflation dynamics, as captured by the Phillips curve? (3) Has it contributed substantial negative shocks to the inflation process? The answers to these questions are no, no, and no."

There is a caveat though. Most of the work so far I have cited is from US. Still looking at papers that give a more global outlook. Anyways, happy reading on inflation and globalisation.

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