This has been reflected, since late summer 2017, in a growing discrepancy between the growth of the GDP deflator and core inflation. The GDP deflator has followed a more pronounced upward trend, rising from 0.6% at the end of 2016 to 1.5% at the end of 2018. One development that may have contributed to lower imported inflation was the appreciation of the euro exchange rate by around 8% in nominal effective terms over the last two years. ECB internal analysis suggests that this had an impact on non-energy industrial goods inflation in 2018, especially for durable goods.15 The upshot is that the pass-through of wages to prices is likely to be moderate until these various factors have played out. But there are several reasons to believe that they will unwind over the medium term. Our monetary policy will remain accommodative and will respond to any changes in the inflation outlook. The effects of exchange rate appreciation have now reversed. Demand should recover, so long as the downside risks to our outlook do not materialise. And with stronger demand, firms should be able to rebuild margins. Moreover, even if the economy were to slow more than expected, the risks to wage growth may be contained. Since the end of 2017, wage growth has been driven less by wage drift16 and more by negotiated wages, which are more persistent and react more slowly to cyclical labour market conditions. Negotiated wages for 2019 have to a substantial degree already been set by previous negotiating rounds.
For emerging economies, capital flow volatility is a fact of life and something that policy makers have to deal with; and we have to acknowledge that the size and volatility of capital flows will only intensify. While the transmission of global shocks to the domestic economy through the real economy channel – that is through trade and investment – is something that we have been dealing with for decades, policy makers today are confronted with the increasingly dominant channel of 1/3  BIS central bankers' speeches  transmission of shocks through the financial markets, at least in the immediate term. All of us have experienced how spillovers from external developments that were manifested through capital flow volatility have adversely affected domestic financial markets, asset prices, liquidity conditions and importantly, exchange rates. All these challenges make for a complicated policy environment for ASEAN central banks. Gone are the days when keeping our own house in order is enough. Sure, good fundamentals matter as they have no substitute. They are, however, no longer sufficient. As Keynes rightly pointed out a long time ago, “the market can stay irrational longer than you can remain solvent.” Often, we have seen how external developments that are beyond our control, such as the unprecedented quantitative easing by the advanced economies and the subsequent Taper Tantrum, triggered periods of large inflows followed by sharp reversals in emerging economies with severe consequences. For small open economies, these flows can easily overwhelm the domestic financial markets and lead to build-up of vulnerabilities in the economy.