I would like to address a more fundamental issue, concerning the ability of our current analytical tools to capture the changes which have taken place over the last two decades. As surveillance is ultimately based on a conceptual framework, then if that framework is biased, we are inevitably less able to capture imbalances and to detect risks to the world economy. So it’s important to assess whether the crisis has challenged some of the main assumptions of our framework. Work in this area has already started, to some extent. One key assumption which has been challenged, for instance, regards the efficient market hypothesis. In prevailing models, markets are assumed to price risk efficiently and to reflect underlying fundamentals. Thus, as long as asset prices do not reflect a change in the market assessment of risk, the risk is assumed not to exist or is underestimated. And often policy-makers behave as if the risk simply didn’t exist as has been the case for sovereign risk or inflation risk. I would also like to examine another fundamental assumption of our economic models which has largely gone unchallenged, or at least has been insufficiently considered in my view. It is the impact of “globalisation”, i.e. the strong and sustained growth of emerging market economies (EMEs), on the long-term trends of the world economy, including the effects on advanced economies (Charts 1 and 2).
Of course, this depends on supply elasticity. However, it may take time to develop new sources of supply that can keep up with demand. The increase in commodity prices weighs negatively on countries which consume more of these products – mainly the advanced economies – and on those with lower productivity growth. Another “negative-impact” channel is the Balassa-Samuelson effect, according to which prices of manufactures and services in EMEs increase more rapidly than in advanced economies. To the extent that these prices remain lower than those in advanced economies, any increase will worsen the latter’s terms of trade, especially if domestic production is limited or has been totally offshored. To sum up, there is a need for more analysis of how growth potential is affected by ongoing developments, such as globalisation. My impression is that there is too little work being done on this issue; I fear that we will exit from the crisis with the same old analytical instruments and assessment that we had prior to the crisis – the very same ones which were responsible for the insufficient surveillance of economic developments and policies. 3  L. Bini Smaghi (2009) “Towards the G8 – strategies for emerging from the crisis”, LUISS Guido Carli University, Rome 27 May 2009. BIS central bankers’ speeches  3  Inflation Inflation is the second way in which the strong, steady progress of the EMEs is affecting advanced economies (Chart 5).