GLOBALIZATION AND INFLATION
November 7, 2005
In the latest annual report of the Bank for International Settlements (BIS), the authors suggest that global forces have become more important than domestic factors in determining inflation in individual countries.
The correlation between core inflation and the growth in unit labor costs in America fell to only 0.3 in 1991-2004, from nearly 0.8 in 1965-79; the link between inflation and labor costs has also faded in other developed economies, says BIS.
This probably reflects two things, says BIS:
- The integration into the world economy of China and other emerging markets with vast suppliers of cheap labor has curbed the bargaining power of workers in developed economies.
- Fiercer global competition has made it more difficult for firms to pass increases in wages through to prices.
- Fluctuations in import prices also have much less impact on core inflation than they once did; similarly, the link between movements in exchange rates and import prices has sharply diminished.
- Increased global competition has limited the room for firms to pass on higher costs and as a result, domestic cost pressures, whether in labor or energy, no longer lead automatically to higher inflation, but are more likely to show up as swings in profit margins.
Central banks need to pay less attention to domestic shifts in unemployment and capacity utilization and more attention to the global balance between supply and demand. But this does not relieve central bankers of their responsibility for maintaining price stability; though it might require them to steer policy in a different way, says BIS.
Source: Editorial, "A Foreign Affair: Inflation is increasingly determined by global rather than local economic forces," Economist, October 22, 2005.
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