During the bust phase of the asset price cycle, the associated credit crunch might lead to an economic downturn and a negative deviation from the objective of consumer price stability, and possibly even to deflation, which would exacerbate a financial crisis. An environment of abundant monetary liquidity can affect the risk-taking behaviour of investors and financial intermediaries. Ample monetary liquidity and financial market liquidity 23 could be indicators of the ongoing execution of arbitrage strategies, such as carry trades, and short-termist or myopic “search-for-yield” behaviour, which can temporarily distort the pricing of risk. 24 It is not low inflation itself but rather low rates of return, which could trigger “searching-for-yield” investment strategies, providing financial market liquidity to previously much less liquid markets and affecting relative asset prices. In fact, ECB research shows that there is evidence that monetary liquidity shocks have played a role in driving asset prices, particularly housing prices across OECD countries, during the boom phase of asset price cycles, and that these shocks have also to explain the negative effects on economic activity during the subsequent bust phase. 25 The intriguing aspect of this hypothesis, and of the associated empirical findings, is that the monetary policy stance might be perfectly appropriate for and consistent with the preservation of price stability over the medium term. Nevertheless, the potential implications for asset price boomand-bust-cycles could signal that the monetary policy stance could prove accommodative for maintaining price stability in the long run.
It has been suggested by some that the effectiveness of monetary policy could be impaired as a consequence of the impact of globalisation on the structure and functioning of markets – product, labour and financial markets – which would affect – and in the extreme disrupt – important channels of the transmission mechanism of monetary policy. Various effects have been discussed and analysed, and a number of empirical studies have attempted to estimate their quantitative significance. Simply put, globalisation could undermine the effectiveness of monetary policy as a result of its impact on both domestic aggregate demand and aggregate supply. The channels through which monetary policy influences aggregate demand could be impaired if domestic interest rates and domestic aggregate demand are increasingly determined by  BIS Review 9/2008  1  global factors rather than domestic monetary policy. On the supply side, globalisation could affect inflation dynamics in various ways, notably by reducing the responsiveness of domestic inflation to domestic firms’ marginal cost increases, by making “global economic slack” rather than the domestic output gap an important determinant of domestic inflation pressure, and possibly by influencing the trend rate of change in the terms of trade. Effects of globalisation on aggregate demand With regard to the influence of globalisation on domestic aggregate demand, two arguments have been advanced.