Commentary: Impact of Globalization on Monetary Policy

If you ask the average businessperson why inflation has been low during the past decade, he or she is almost certain to reply that it is down to cheap imports from the Far East and Eastern Europe. Monetary policy probably won’t get a look in, yet we know that inflation must ultimately be a monetary phenomenon. The answer, of course, is that globalization represents a shock to relative, not absolute, prices. What happens to the general price level depends on what monetary policy makers decide to do. But there is, as Ken notes, a grain of truth in the popular view, in so far as the beneficial terms of trade shock have temporarily lowered the natural rate of unemployment and provided a favorable “tailwind” to central banks’ attempts to hold inflation down.