Fourth, taking a longer term perspective, beyond the current crisis, we need to continue to improve our understanding of monetary policy in a globalized world. What other important ingredients need to be considered when implementing monetary policy or when forecasting growth and inflation ahead? The role of external shocks is likely to become more important and needs to be considered more carefully. We need to find ways to anticipate these shocks including the future financial architecture and improve upon limitations in our foresight and in the forecasting ability of our models. Fifth, the role of policy makers in other countries which will add to these external shocks opens up room for greater policy coordination and cooperation at the international level. Like other previous crises, the current crisis is likely to be followed by discussion about intensive reforms at the international level. We should grab this opportunity to highlight the need for international cooperation in monetary policy in maintaining global financial stability. I don’t need to point out that international cooperation in the area of supervision is far ahead, both in normal times and in time of crisis. In order to secure international cooperation in monetary policy, we need more research and dialogues on how to make early warning and surveillance really work at a global level. In addition, coordination may not be enough; a redesign of global financial architecture may be necessary, and we need to work on this area as well.
But the important point here is that financial innovations, coupled with technological advances in communications, helped to link financial markets across the globe. This globalization of financial services allowed the collapse of major financial centers to spread to the rest of the globe so efficiently. In fact, these very financial instruments which had been earlier used to diversify risks turned out to be the very means for spreading contagion. The spread of the impact of the financial crisis onto the global real economy through the trade channel changed the world’s economic outlook rapidly and dramatically. This had a drastic impact on the inflation outlook, and the threat of inflation has rapidly shifted to one of possible deflation. At the same time, central banks are running out of traditional monetary policy ammunition to fight the slowdown in growth and potential deflation – namely cutting interest rates. Given the increasing influence of external factors on global inflation dynamics, traditional monetary policy which focuses on domestic dynamics of inflation needs to be reconsidered. As a result of globalization, the prices of important commodities and goods tend to move together, making external price shocks a more and more important determinant of domestic inflation. Fluctuations in oil prices and other commodity prices, or even a sustained period of cheaper or dearer exports, can change global inflation dynamics.