Following the joint meeting of the ASEAN+3 Finance Ministers and Central Bank Governors in May this year, a press statement was released on their common position with respect to both macroprudential measures and capital flow management measures. I quote: “…deepening global financial integration …require MPPs and CFMs that counter increases in financial stability risks from changes in macroeconomic policies in countries with major currencies.” Beyond the resilience of policy frameworks, my third and final point has to do with the resilience of domestic fundamentals. Firstly, having a diversified, flexible and competitive economy is a key strength in dealing with instability from the external sector, whether it is in the real economy or in the financial system. Secondly, having a strong and resilient financial system is an important source of strength against vulnerabilities rising from living in an integrated world. In the period after the onset of the financial crisis in the AEs, many Asian economies have been able to sustain growth because their financial systems were healthy and were able to finance and support domestic economic activity even as growth in the AEs disappeared. A deeper and more diversified financial system can also help to intermediate capital inflows in a less distortionary manner. In the post-crisis period, we have been pleased that the depth of the financial markets in Malaysia and the presence of large institutional players have contributed to stability in the domestic financial markets, even in the face of significant volatility in foreign portfolio flows.
Let me focus on some of the implications of global economic and financial integration for central banks. What does globalization change and what does it not change? What complications does it introduce and what challenges does it ease? This is a vast and complicated topic, but I want to touch on some of the key issues. In passing, let me note Federal Reserve Vice Chairman Don Kohn’s recent assessment of what we know about the impact of globalization on short-run inflation dynamics in the United States and elsewhere. He noted that the evidence so far on these questions is “far from conclusive” but for the most part it suggests that to date the effects have been gradual and limited. There are, however, some important things we know about how economic integration affects the context in which central banks operate. For example, Harvard economist Ken Rogoff and others have pointed out that to the extent that globalization increases the degree of competition, it can reduce the “inflationary bias” or, to put it differently, it can strengthen the anti-inflation credibility of a central bank. By inducing greater price flexibility, competition lowers the short-run gains to output from an unanticipated inflation, and thus permanently reduces the incentives for a central bank to try to exploit those gains. The improved credibility of the central bank’s commitment to keep inflation low and stable should, in turn, allow it to deliver better inflation outcomes with fewer short-run costs to economic growth and employment.