We also know that there are a variety of mechanisms associated with globalization that lower the trajectory of inflation in the short run. For example, as the potential growth rate of an economy rises, it may experience more growth with temporarily lower inflation. But none of globalization’s effects on inflation, not even the potential reduction in inflationary bias, diminish the importance of the principal objective of central banks: setting policy to achieve low and stable rates of inflation over time. Doing this well requires the central bank to be able to discern features of the economy that it cannot know with precision - like the potential growth rate or the equilibrium real interest rate. It also requires a central bank to define and measure inflation in a meaningful way. We live in a world where the prices of some goods and services move in different directions and at different rates. The challenge for monetary policy makers is to look at this complex and changing picture of price changes and try to gauge the forces that are operating on underlying inflation and so judge the likely future path of overall inflation. As economies become more integrated, and as the share of goods and services that are “tradable,” or are affected by trade, increases, the challenge of extracting some measure of underlying or trend inflation gets more interesting. External factors can have bigger effects on the movements of some prices. The nature and duration of the external impulse or “shock” to relative prices may be hard to discern.
Moreover, the situation had worsened as it added to the direct impact of weakened global demand. Although the spillover impacts to individual economies have been uneven, monetary policy in most emerging markets have faced a tradeoff between achieving domestic objectives and managing external spillovers. The limited and, in many cases, stretched monetary policy tools have been designed to mitigate financial imbalance and vulnerability, and to restore economic growth and maintain targeted inflation. Our experiences from various Quantitative Easing (QE) episodes remind us that the traditional monetary policy at hand may not be sufficient to address these multiple objectives. Alongside policy interest rate as a primary tool, central banks in emerging markets have additionally relied more on non-traditional, tools and measures. One is macro-prudential policies, mostly related to real estate and the banking sector, to help address pockets of vulnerability in the short-term. The other is a more market oriented approach by allowing greater exchange rate flexibility to counter large and volatile capital flows. Thus far, it is evident that emerging market economies have weathered such spillovers quite well, but new challenges keep coming our way. Despite signs of recovery in some Advanced Economies, their paths remain uneven. This called for the divergence of policy implementations with substantial uncertainty, especially to financial market participants. Next, the prolonged stagnation in some Advanced Economies has taken more tolls on emerging economies as reflected by softening growth and heightening vulnerabilities.