There is a great deal of research in the current literature on how globalization, inflation, and other monetary policy attributes interact. Many studies explore globalization’s potential short- and long-term effects on lower inflation rates among developing economies.
Others argue that globalization is responsible for creating a favorable environment that helps maintain lower inflation levels by steepening the output-inflation trade-off faced by central banks. Steepened the Phillips curve makes this commitment more durable and credible.
In addition, many economists believe that the core mechanism that drives lower inflation levels through globalization comes from the influx of global competitors into an economy with openness to trade. This tends to weaken domestic monopolies and the power of labor unions, providing more price and wage flexibility while reducing the output gain reaped by monetary policy expansion for any given inflation impulse.
Globalization and Inflation Dynamics
The Bank of International Settlement’s (BIS) working paper (2019) found that global factors significantly impact inflation rates in many advanced economies. These factors include changes in the world output gap, commodity prices, and exchange rate movements. Domestic factors, such as the domestic output gap and inflation expectations, also play a role in influencing inflation rates. However, the role of domestic slack has decreased over time.
These findings vary depending on the country and period being studied. For some countries, global factors are more critical in determining inflation rates. However, for others, domestic factors are more significant. The researchers note that policymakers should consider both global and domestic factors when setting inflation targets and crafting monetary policy. Updated inflation models considering global factors are necessary to provide an accurate picture of inflation dynamics.
However, domestic slack and inflation expectations remain essential factors in Core and trend inflation rates, respectively. Therefore, policymakers must keep track of global and domestic economic conditions to ensure their policies effectively achieve price stability.
To explore whether or not globalization has played a role in inflation dynamics over the last decade. The other papers found that global factors have played a more significant role in inflation dynamics in recent years but that domestic factors are still important. Specifically, global variables are more important for understanding CPI inflation dynamics than wage inflation. Domestic slack plays a significant role in many specifications and inflation measures, especially core and wage inflation.
The papers raise many new questions that remain to be answered, highlighting the role of central banks in looking-through changes in inflation resulting from global factors. While global variables are more important for understanding CPI inflation than wage inflation, they do not replace traditional domestic explanations—both continue to play a meaningful role in determining inflation dynamics.
The results of many pieces of research have shown that global factors have a significant impact on domestic inflation and inflation expectations. They found that the importance of local versus global factors depends on the policy horizon. Additionally, they found that the globalization of inflation is also reflected in the globalization of expected inflation. This has important implications for how monetary authorities should respond to oil price shocks. Therefore, it is critical to understand the aggregate supply from aggregate demand components of shocks in order to understand the dynamics of both observed and expected inflation.
Analysis of globalization effects on Philips Curve
GDP growth rates have been weak since the global financial crisis of 2008, which was particularly severe in industrialized countries.
As a consequence, inflation levels have also remained very low, especially when compared to historical standards. The impact of this dip in economic output upon individual countries has been offset somewhat by exporting cheap goods into international markets largely influenced by developing economies.
However, as a result of China’s enormous influence on inflation rates in many nations, there is considerable dispute about the extent to which Globalisation has impacted inflation levels.
The impact of Globalisation on emerging economies is particularly well-documented. Chinese products are often very cheap compared to products manufactured in developed countries, becoming increasingly popular in international economies. For example, steel price has dropped by approximately half since 2011.
This rise in popularity is demonstrated by China’s exports to other countries doubling over that same timeframe. The result is that the Phillips curve has steepened during this period.
Developed economies are also beginning to experience a fall. This has led to a rise in competitiveness for businesses in developed countries, where governments can control inflation effectively.
The Phillips curve is used as a measurement of the effects of inflation by examining economic output. The structure of this relationship appears to be curving downward, with higher levels being associated with more minor price increases.
This means that if there is high unemployment, there should be low amounts of inflation.
Economist’s view on Phillips curve Phenomena
According to monetarist economists, an increase in globalization should result in higher consumer prices because inflation is believed to be fueled by an increase in the money supply. This would be expected to cause the Phillips curve to become more curved. However, the Phillips curve has been observed to become shallower since 2008, suggesting that changes brought about by Globalisation have had a minor impact on the Phillips curve.
This, in turn, would suggest that Globalisation has not steepened the Phillips curve. The increase in the Phillips curve suggests that high unemployment and international trade do not necessarily mean there will be low inflation levels.
The Phillips curve was believed to have an inverse correlation between inflation and unemployment. However, after 2008’s global financial crisis coronavirus disease of 2019 (covid-19), it seems that other factors besides employment and international trade levels influence how much the curve bends. This means that the Phillips curve may not be as reliable or accurate as previously believed.
Another view explains that while the enhanced competition stimulated by globalization steepens the output-inflation trade-off, it also closes the gap between the natural and effective output rates, further strengthening the political economy to maintain lower inflation levels.
However, he further contends that in a highly competitive environment, rigid wages and prices are much harder to sustain; hence the globalization effect can dominate over the long run.
Conclusion
So, has globalization steepened the Phillips curve as monetarist economists have predicted? The answer is complicated. On the one hand, there is evidence that suggests globalization has had a minor impact on the Phillips curve. However, other factors, such as increased competition, may significantly impact inflation. In any case, it is clear that changes brought about by globalization are complex and cannot be easily summarized. It seems clear that globalization has affected how businesses operate in developed countries- making them more competitive and forcing them to become more efficient to maintain low inflation levels.
Reference:
Miranda-Agrippino, S., Nenova, T., & Rey, H. (2020). Global footprints of monetary policies. CFM, Centre for Macroeconomics.
Forbes, Kristin J., Has Globalization Changed the Inflation Process? (July 4, 2019). BIS Working Paper No. 791, Available at SSRN: https://ssrn.com/abstract=3420255
Oinonen, S., & Paloviita, M. (2014). Updating the Euro Area Phillips Curve: The Slope Has Increased. SSRN Electronic Journal. Published. https://doi.org/10.2139/ssrn.2545356
Piao, J., & Joo, S. (2014). Estimating Open Economy New Keynesian Phillips Curve for Korea. Asian Economic Journal, 28(3), 239–258. https://doi.org/10.1111/asej.12035
