After adjusting for unconventional policy there’s greater monetary policy divergence than implied by a simple eyeballing of the currently highly synchronised global rates cycle. And there remains the prospect of a further widening. In other words, domestic economic conditions – conditions affected by domestic monetary policy – still very much matter. None of this diminishes the considerable challenges of returning inflation to target in the face of global developments. There are profound secular and cyclical disinflationary forces at work in the global economy, and for economies like the UK their impact is being reinforced by exchange rate movements which will drag inflation down further at the policy horizon. Moreover, as events of the past few weeks have reminded us, a variety of global factors can affect global financial conditions and influence the neutral rate of interest. Central banks must take these Disparate Confounding Dynamics (DCDs) into account when setting policy. 2 Even for those economies with the strongest recoveries and the best functioning financial systems, they mean that the policy rates consistent with returning inflation to target will likely need to rise in a gradual fashion and to a limited extent despite robust domestic demand and firming domestic costs. For the UK at least, global DCDs influence but do not dictate policy. 1  Subramanian, A and Kessler, M (2013), “The hyperglobalization of trade and its future”, Global Citizen Foundation working paper 3, June.
19, 20 Some have argued that this confers a particular responsibility on US policy makers. Yet US policy is not the sole determinant of global rates. Many recent movements in US long-term government bond yields have appeared to be influenced by ECB monetary policy actions. 21 This is in line with some recent evidence that funding conditions in other financial centres, notably the UK and the euro area, affect funding conditions globally and, therefore, the cross-border supply of funds. 22 Moreover, it is the divergence of monetary policies itself rather than the stance of one central bank in isolation that points to more volatility in exchange rates and asset markets with associated effects on global liquidity conditions. 23  17  Not surprisingly in light of its importance, issues related to pass-through are the subject of intense work at the Bank of England. 18  Bruno and Shin (2015). “Cross-Border Banking and Global Liquidity,” forthcoming in the Review of Economic Studies. 19  Rey, Helene (2013). “Dilemma not Trilemma: The global financial cycle and monetary policy independence” proceedings of the Federal Reserve Bank of Kansas City Economic Symposium at Jackson Hole. 20  Cesa-Bianchi, Cespedes and Rebucci (2015). “Global Liquidity, House Prices, and the Macroeconomy: Evidence from Advanced and Emerging Economies”, Journal of Money, Credit and Banking, Vol. 47, Issue S1, No. 1. 21  See May 2015 20150323a.htm. 22  Cerutti, E., S. Claessens, and L. Ratnovski (2014): “Global Liquidity and Drivers of Cross-Border Bank Flows,” IMF Working Papers 14/69, International Monetary Fund.