U.S. Relations With the People's Republic of China (2007)

Board of Governors of the Federal Reserve System

Governor Frederic S. Mishkin
At the Domestic Prices in an Integrated World Economy Conference, Board of Governors of the Federal Reserve System, Washington, D.C.

September 27, 2007

Globalization, Macroeconomic Performance, and Monetary Policy

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Globalization and Inflation

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These effects from the greater price flexibility and increased competition in domestic markets that have arisen from globalization, while theoretically plausible, are often at variance with salient features of the world economy, and so they do not explain why inflation has declined in recent years. However, another very dramatic feature of globalization is that it has brought more than a billion new workers into the global economic system from China and India. Some observers claim that through its sales of low-cost goods, developing Asia--and especially China--has been "exporting deflation" and will continue to do so until wages in these countries rise. Although this effect, too, is plausible, research suggests that its importance should not be exaggerated.

If China were truly exporting deflation, the effect should be evident primarily in the behavior of import prices. Research at the Federal Reserve Board by Kamin, Marazzi, and Schindler (2006) estimates that purchases of manufactures from China have lowered U.S. import price inflation roughly 1 percentage point annually over the past decade, a decline that has led to a short-run lowering of consumer price inflation of about one-tenth of 1 percentage point and a somewhat larger effect over the longer term. Research at the Organisation for Economic Co-operation and Development (OECD) by Pain, Koske, and Sollie (2006) arrives at a similar estimate of the effect of trade in manufactures with developing countries on U.S. inflation: negative 0.2 to negative 0.3 percentage point.

At the same time, the additional demand for primary commodities by developing Asia, especially China and India, is putting upward pressure on global prices of these goods. During 2004-06, the region accounted for about 40 percent of the global growth in demand for oil and more than 70 percent of the growth in demand for copper and zinc. The global commodities boom, which has been stimulated by the emergence of the Chinese and Indian economies on the international scene, has been an important offset to the deflationary effects from their low-priced goods and services.

Analysis by the Board's staff, which weights the negative effect on U.S. inflation from cheaper manufactures against the positive effect from higher commodity prices, finds that the net effect in recent years could go either way but in any case is probably quite small. Looking back before the recent boom in commodities prices, the staff's best estimate is that China's and India's entrance on the global trading scene has had a small negative effect on inflation. Research at the OECD (Pain, Koske, and Sollie, 2006) reaches similar conclusions, finding a net effect of 0 to negative 1/4 percentage point for the United States, the euro area, and the OECD economies in aggregate.

Laurence Ball (2006) makes an important point that cheaper imports from places like China lower relative prices for imported goods but ultimately do not affect inflation, which is the change in overall prices. Following the argument made by Milton Friedman (Friedman, 1975), Ball points out that for every decline in the relative price of one good or service in a price index like the consumer price index (CPI), there is by definition a rise in the relative price of some other good or service. Any pattern of relative-price changes is compatible with a particular level of the inflation rate. What determines the overall inflation rate is not relative prices for one category of goods and services but rather the balance between overall demand and supply in the economy, which ultimately is influenced by monetary policy. Ball therefore takes the view that cheap imports from China and other low-wage economies should not affect inflation.

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Globalization and Output

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That said, as I have emphasized in my speeches and writings (Mishkin, 2006a, b; Mishkin, 2007b), I strongly believe that globalization is and has been a key factor in promoting economic growth. Globalization not only promotes a more competitive economic environment--which forces business to innovate--but it also creates strong incentives for institutional reform to make markets work better. Globalization in recent years has not only enabled hundreds of millions of people in countries like China and India to escape abject poverty (income of less than $1 per day) but has also helped economies like ours in the United States to be highly dynamic, which is essential to our future economic well-being.

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