Jean-Claude Trichet: The governance of globalisation
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the Bocconi
University and Corriere della Sera International Forum 2008, Milan, 12 May 2008.
* * *
It is a great pleasure to be here today at this Forum and I wholeheartedly thank Mario Monti
for having invited me. After presenting some key features of globalisation, I would like to
discuss their implications for inflation and monetary policy, as well as issues related to the
governance of globalisation at the international level.
Globalisation, while frequently quoted in many circles, is a rather broad concept open to
many definitions. To my mind, a succinct general characterisation of globalisation in the
current context can be thought of as essentially consisting of two main elements.
First, globalisation involves the entrance of new participants into the global market-place. On
this count, there has been a significant expansion in global productive capacity over the last
decades. This has come through the opening up of emerging economies to international
trade and production, notably the greater involvement of emerging Asia in world trade, as
well as Central and Eastern Europe following the collapse of the Soviet Union. On the basis
of one measure, an export-to-GDP weighted labour force, the effective global labour supply
quadrupled between 1980 and 2005, with much of the increase having occurred since 1990.1
The second main element of globalisation is the growing interdependence between both
existing and new participants via trade, production and financial market linkages. Trade in
doubled
goods and services has effectively over the last 20 years, with world imports and
exports of goods and services as a share of world GDP having increased from 33.9% of
world GDP in 1986 to 60% of world GDP in 2006. The increase in interdependence on the
financial side has been even more impressive, with the share of gross international asset
holdings in world GDP - which provides a measure of financial openness - having exhibited
an eightfold increase over the last 25 years; now standing at more than 130% of world GDP.
Indeed, global cross-border capital flows have been growing at an extremely robust pace
over the last decade, increasing threefold as a percentage of GDP.2 For the euro area over
the last decade, the stock of outward and inward foreign direct investment has virtually
doubled
as a percentage of GDP since 1999.
Ultimately, these globalisation forces provide the scope for many economic benefits,
including more efficient resource allocation, along with welfare gains from deepening
specialisation, cheaper products, and greater product choice. But as the economic and
financial effects of a changing global landscape are multifaceted, they imply several policy
challenges at both the domestic and international level. I do not intend to address all of these
policy challenges today, rather, I would like to focus on two specific challenges: the
implications of globalisation for inflation and monetary policy, and the governance of
globalisation at the international level.
Globalisation and its implications for inflation and monetary policy
The aspects of globalisation I have been describing thus far entail many important
macroeconomic consequences for the euro area as well as other global regions.3 Perhaps
most crucial from a central banking perspective is the impact on consumer price inflation.
While several ways of classifying the impact are possible, I think that a simple taxonomy of
globalisation's influence on inflation into two main channels - direct and indirect - provides a
useful one in characterising the effects on inflation.
First, globalisation has strong direct effects on price movements of certain goods and
services, and in this sense can be thought of as a shock exerting a strong influence on
relative price dynamics. On the one hand, increasing trade openness seems to have had a
downward impact on manufacturing price developments over the last decade or so. In the
euro area, rising imports from lower-cost countries, mainly from China and the new EU
Member States, appear to have put downward pressure by an average of approximately
2 percentage points per year on extra-euro area manufacturing import prices over the period
1995-2004.4 On the other hand, globalisation and its implications for global demand, has
implied strong increases in other prices. Here, I am thinking of the upward pressure from
commodity prices that derived from strong growth of commodity imports by emerging
markets - both concerning energy and, more recently, food. These price rises have been
impressive to say the least. Since 2002, the price of Brent oil has risen more than five-fold in
US dollar terms, while the price of non-ferrous metals has risen more than three-fold. Since
the beginning of 2006, such large price increases have also extended to food - with at least
a doubling in the price of wheat, maize and soybeans. While I would not claim that
globalisation has been the only factor underlying these price developments, it has certainly
played a role through boosting demand for such commodities.
In this way, judging globalisation's impact on aggregate prices depends on the balance of
these relative price movements. While relative price movements are always present and in
this way need not affect aggregate inflation, they could embed short-term aggregate impacts
either to the extent that the movements are sizeable or that adjustment frictions and
imperfect information imply a prolonged impact. Empirical studies estimating this relative
price effect suggest a small net downward impact of trade openness on annual consumer
price inflation over the period of five to ten years up to 2005.5 Since that time, the balance of
relative price shocks as characterised above could very well have become inflationary.
While influences on relative price movements of goods and services are among the most
visible aspects of globalisation, its influence on inflation, however, does not stop there. A
second channel involves the effects of globalisation on prices through competitive forces.
Prima facie, increased competitive pressures would be expected to both dampen firm profit
mark-up behaviour while also potentially altering developments in costs (such as the cost of
capital and labour) which underlie price dynamics. In contrast to relative price effects, which
have a complex, because bipolar, ex-ante impact on inflation, these competitive effects
would be expected to unambiguously exert a moderating influence on inflation as long as
impediments to competition are not in place. Evidence to validate this channel is,
unfortunately, fairly difficult to gather owing to the complex nature of the markup formation
process along with measurement issues. What we do observe is that the responsiveness of
prices to changing demand conditions has, if anything, fallen to some extent over the last
decades - which would be at odds with the notion that firms are more active in adjusting their
mark-up behaviour in a competitive environment. In the context of globalisation, there may
be reason to believe that, in integrated markets, local labour market conditions become less
and less important for domestic price setting, in particular if factors of production (capital and
labour) become increasingly mobile. On balance, however, empirical evidence provides
mixed support for the notion that global measures of economic slack played a large role in
the observed weakening in the relationship between prices and common measures of
(domestic) economic slack in the euro area.6 Indeed, this weakening has to be judged in the
context of a multitude of economic and also policy factors.
The streamlined characterisation of price effects I have described thus far, of course, does
not capture the numerous and complex other aspects of globalisation relevant for monetary
policy. In particular, in addition to trade globalisation and its price effects, financial
globalisation could also impact on other phenomena relevant for monetary policy, such as
global liquidity and long-term interest rates. I will not go through an inventory of such effects
but, rather, assert that despite such a changing environment brought about by globalisation,
central banks still importantly retain the ability to control short-term interest rates and - by
extension - still exert a very strong influence on the domestic cost of financing.
But allow me to return to my specific example of globalisation's price effects and ask, with
such impacts of globalisation on inflation, what is the best possible response of monetary
policy? I would argue that guaranteeing price stability is as essential as ever. A clear and
transparent definition of price stability contributes to a firm anchoring of inflation expectations
in the face of considerable relative price shocks. Indeed, though the effects of globalisation
on inflation I have described thus far may be operative in the short term, monetary policy
ultimately determines inflation over the medium term. The current situation today provides a
useful example in this respect. While monetary policy has limited power in the short term to
stem external price shocks such as the sudden increase in the relative prices of food and
commodities, medium term price stability can be delivered by preserving the firm anchoring
of inflation expectations and by ensuring the absence of second-round effects. Indeed, the
medium-term orientation of the ECB monetary policy strategy ensures that the Governing
Council duly discounts short-term price volatility and transitory movements in inflation.
Domestic price stability is also a precondition for economic stability in the face of external
shocks. A strong focus on domestic price stability also facilitates efficient adjustment of the
economy to macroeconomic shocks. Of course, while monetary policy provides the
foundation for efficient and beneficial adjustment, ongoing structural changes such as
globalisation also intensify the need for more flexibility in product and labour markets.
Greater microeconomic flexibility would not only allow our economy to take better advantage
of the opportunities provided by globalisation, but would also facilitate macroeconomic
adjustment in the wake of shocks and improve the resilience of the economy.
Taking a strict focus on domestic price stability as given, continued cooperation amongst
central banks can also contribute to global financial stability, for instance in the form of
dialogue between central banks and a concerted contribution to solid international financial
architecture - an issue to which I will turn next. Before moving to this next topic, I should
underline, however, that by international cooperation I do not mean coordination. The major
economies of the world have to run their own monetary policies, attuned to their domestic
conditions, in line with their responsibilities in terms of price stability. The world economy is
becoming more integrated but at the same time the various economies that are influential at
a global level remain different, with characteristics that are not alike, including in terms of
market flexibility, and they have to cope with idiosyncratic shocks that can be equally
different. This requires naturally different responses from the policy-makers of central banks
around the world.
The governance of globalisation at the international level
As I have already alluded, to ensure that the process of globalisation occurs in an orderly
manner, the international financial architecture plays indeed a crucial role. It is the
institutional foundations of the global economic and financial system, which deserve credit for
making sure that the tremendous benefits stemming from the integration of national
economies clearly outweigh the also existing challenges. While each global financial
turbulence is different and has different triggers and repercussions - think for instance of the
Asian crisis of the late 1990s and the very significant global financial market correction of
today -, such events have in common that they are really global. As such, they require, in
addition to appropriate policy responses at the national level, also determined policy
cooperation at the international level. Let me take a closer look at some key international
governance structures and rules that provide mechanisms for crisis prevention and crisis
resolution in the global economic and financial system. My first focus is on the surveillance
activities of the IMF - in particular its multilateral surveillance as well as surveillance over
exchange rates and exchange rate policies - and current efforts to adapt them to evolving
needs. I will then share with you some thoughts on how the international institutions and fora
are responding to the present financial situation and related episodes of turbulence and
volatility.
As mentioned earlier, national economies are increasingly interconnected so that changes in
the economic and financial conditions of one country, to varying degrees, impact the situation
in other countries. The Fund has responded to these far-reaching developments by adjusting
its surveillance over its members' economic situation and policies. Bolstering the multilateral
and cross-country perspectives in its bilateral surveillance and placing greater focus on
international economic and financial linkages and spillovers is indeed the right approach.
Moreover, cross-checking between multilateral and bilateral surveillance should help
promote policies at the national level that are consistent with other domestic policies as well
as global adjustment within the international monetary system. In the context of this ongoing
monitoring, which enables the IMF to combine its cross-country and cross-regional
experience, I would see a clear merit in the Fund distilling national best practices.
As far as the Fund's multilateral surveillance instruments is concerned, I would like to recall
that the international community agreed in Spring 2006 to expand the Fund's surveillance
instruments and to launch a new supplementary consultation procedure in a multilateral
format. The first such multilateral consultation has focused on the issue of global payments
imbalances and involved several systemically important economies, namely China, the Euro
Area, Japan, Saudi Arabia, and the United States. I do believe that the multilateral
consultation is an innovative and useful tool as it brings together relevant players for a
meaningful dialogue on a very specific global matter. Looking at the multilateral consultation
on global imbalances, it is worth noting that all parties to this consultation are in agreement
that reducing imbalances in a manner compatible with sustained global growth poses a
multilateral challenge to be addressed as a shared responsibility.
Let me now turn to the events we are currently witnessing in the global financial system,
which illustrate the vulnerabilities of the system and point to shortcomings on the part of the
public authorities as well as in the private sector. With the global financial system still
undergoing a process of de-leveraging and risk re-pricing, the risks to global and financial
stability should not be underestimated. Signs of these risks, inter alia in domestic and
external real and financial imbalances, should be addressed resolutely by the relevant
parties. It is therefore highly welcome that, in view of the ongoing turmoil, the international
community promptly called for a concerted response aimed at identifying the weaknesses,
drawing comprehensive lessons and formulating policy responses with a view to
strengthening the resilience of the financial system. Work has progressed intensively both at
the international as well as the EU level.
I will highlight the important work being done by the Financial Stability Forum (FSF) and its
excellent report on enhancing market and institutional resilience, which was recently
released to G7 Finance Ministers and Central Bank Governors. The G7 identified a number
of recommendations by the FSF that are considered among the immediate priorities for
implementation within the next 100 days. Financial institutions, for instance, should fully and
promptly disclose their risk exposures, write-downs and fair value estimates for complex and
illiquid instruments in their upcoming mid-year reporting. Moreover, the International
Accounting Standards Board (IASB) and other relevant standard-setters should take urgent
action to improve the accounting and disclosure standards for off-balance sheet entities and
to enhance guidance on fair value accounting, particularly on valuing financial instruments in
periods of stress. What is also relevant is that financial institutions should strengthen their
risk management practices, including rigorous stress testing, under the support of
supervisors' oversight. Finally, by mid-2008, the Basel Committee on Banking Supervision
("Basel Committee") should issue revised liquidity risk management guidelines and the
International Organisation of Securities Commissions should revise its code of conduct for
credit rating agencies. Additional measures that are to be implemented by end-2008 relate to
strengthening prudential oversight of capital, liquidity and risk management and enhancing
transparency and valuation. Moreover, the role and uses of credit ratings should be changed,
the authorities' responsiveness to risk strengthened and arrangements for dealing with stress
in the financial system implemented.
Other international bodies and institutions that have responded to the financial turbulences
include the Basel Committee on Banking Supervision which just announced that it will take a
number of steps to bolster the resilience of the banking system to financial shocks.
Moreover, the IMF is sharpening its analysis of the financial sector and macro-financial
linkages. It is welcome that the Fund places greater focus on financial sector analysis in
Article IVs and continues its emphasis on Financial Sector Assessment Programmes. In this
context, I would highlight that all 27 member states of the European Union have either
already completed an FSAP or confirmed their future participation. It is welcome that a
number of countries, including some systemically relevant ones, have expressed their
intention to undergo an FSAP exercise.
At the EU level, the Council of European Ministers of Finance (ECOFIN) has coordinated
work aimed to strengthen supervisory and financial stability arrangements. This relates to the
introduction of a European mandate for national supervisors, the clarification and
strengthening of the functioning of the committees of supervisors at the level of the 27 EU
member states and the wider use of colleges of supervisors to re-enforce the supervision of
cross-border banking groups. Moreover, a Memorandum of Understanding on cross-border
cooperation in financial crisis situations between all relevant authorities in the EU, that is
supervisory authorities, central banks and finance ministries, has been signed.
In sum, a number of significant initiatives are underway at the various levels of governance of
the global financial system to respond to the challenges of globalisation. To ensure that the
responses by the bodies and forums in charge of global economic and financial stability are
effective, it is of course crucial that they collaborate closely and complement each others'
efforts. This should also be the case as regards the interaction between the FSF and the
IMF.
Conclusion
The phenomenon of globalisation entails many important changes to the global
macroeconomic, financial landscape. Associated with this, it entails many policy challenges -
both in terms of domestic macroeconomic policies and the international financial architecture.
At the domestic level, a key challenge for monetary policy is to actively monitor changes in
the inflation process, while continuing to solidly anchor inflation expectations. The strong
relative price movements associated with globalisation make a firm focus on price stability is
as essential as ever. At the same time, such a sound monetary policy framework can lay the
foundations for fostering benign economic adjustment so that the euro area realises the
many benefits associated with globalisation. Of course, policy challenges do not stop here -
notably, greater microeconomic flexibility would also be essential to both allow our economy
to take better advantage of the opportunities provided by globalisation, but would also
facilitate macroeconomic adjustment in the wake of shocks and improve the resilience of the
economy.
At the international level, looking at the implications for the governance of globalisation, I
believe that a key contribution that the institutions and informal bodies and forums in charge
of global economic and financial stability make to strengthen the resilience of the global
financial system is to foster information-sharing and increase transparency. It is the access to
information that facilitates investment decisions, the management of risk and market
discipline. These effects are of course particularly important in times of market volatility as
they lessen herding behaviour and contagion.
Moreover, with the global economic and financial landscape constantly changing, it is
essential to establish market-based policy frameworks and to pursue sound domestic
policies, while regularly updating the various institutions and forums that form the
international financial architecture. This relates both to the format of these institutions and
forums as well as to the policy issues that they deal with. Doing so ensures that the benefits
stemming from the process of globalisation are maximised. As I have set out earlier,
policymakers are not complacent: they do live up to this important task and adapt the
international financial architecture where necessary, thereby bolstering the shock-absorbing
capacity of the global financial system.
I thank you for your attention.