Sep 6, 2019

Globalization may be changing the fundamentals of economics

Dion Rabouin, author of Markets

Photo: Biddiboo/Getty Images

Globalization has played an increasingly large role in determining the rate of inflation over the last decade, asserts a new Brookings paper from MIT global economics professor Kristen J. Forbes.

Why it matters: With inflation more "determined abroad" than ever and outside the control or purview of central banks, it may be time for a major overhaul in the way they operate.

  • That has major implications for everything from government policy to stock market returns.

Details: In her paper, Forbes highlights 4 areas of globalization that affect inflation:

  • increased trade flows
  • greater use of supply chains to optimize production costs
  • greater role of emerging markets and their impact on commodities
  • and a reduction in the bargaining power of workers.

What it means: Globalization has helped increase company profits by opening up new sales destinations and increasing trade, while also making trade more efficient.

  • It also has allowed companies to ship jobs and services overseas to populations that demand far lower wages, changing the way both workers and companies negotiate wages.
  • This has given employers a decided advantage and has been a major factor in depressing wages and holding back inflation in developed countries like the U.S.

The big picture: The study's findings also suggest that central banks may be losing their power to direct the economy. If raising and lowering interest rates does not produce a corresponding reduction and increase in inflation, then central banks' role as financial arbiters may need to be revamped.

Between the lines: With inflation having failed to exceed the targets of the Fed, European Central Bank and other major central banks, pressure has grown for them to focus more on stimulating economies to provide maximum employment.

  • Focusing on economic stimulus is a central tenet of modern monetary theory (MMT), a previously fringe idea that is gaining acceptance among larger segments of the populace.

The bottom line: If central banks can't completely control inflation, efforts to stimulate or rein it in may be misplaced and/or generally ineffective.

  • Additionally, the findings could mean central banks can afford to focus more of their efforts on pursuing a “high-pressure” economy that pushes unemployment well below a supposed natural rate, rather than being obliged to pump the breaks on the economy when it starts to get hot.

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