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.
8 Kenneth Rogoff has agued that inflation becomes more responsive to domestic excess demand if price rigidities are reduced and the economy becomes more flexible as a result of increased competitive pressure induced by globalisation. The proposition that a measure of “global economic slack” rather than the domestic output gap is a more important determinant of domestic inflation pressure has been discussed extensively. This hypothesis, if valid, would imply that the slope of the short-term Phillips curve, which depicts the responsiveness of inflation to domestic excess demand, becomes flatter. 9 Thus, in a globalised world – so it has been argued – a much stronger monetary policy response would be required, other things being equal, to preserve price stability over the medium term in the presence of adverse shocks. But also in this regard there exists no robust empirical evidence or solid and convincing theoretical foundation to support the claim that a structural change has taken place. 10 Empirical estimates for the euro area do not show a significant change in the slope of the short-term Phillips curve. Furthermore, it would be misleading to interpret the recently observed low correlation between domestic output gaps and domestic inflation in some countries as a structural change in the short-term Phillips  6  See Kroszner (2007). 7  See Bean (2006a and 2006b). 8  See Rogoff (2004, 2006). 9  See Borio and Filardo (2007). 10  See Ihrig et al. (2007). BIS Review 9/2008  3  curves.