# 2.6. Complications introduced by globalization

Finally, globalization changes the environment in which LIC central banks operate in significant ways, both aggravating and easing the challenges they face in attaining their objectives. Consider the following four aspects of globalization: (i) increasing size of the domestic traded goods sector, (ii) increasing volume of inflows of workers’ remittances in many LICs, (iii) larger presence of foreign-owned banks in the domestic economy, and (iv) increased (although still limited) integration with the international financial market.

Understood in this way, globalization has several effects on the environment in which LIC central banks operate. First, globalization is likely to alter the stability properties of the domestic economy in complicated ways. It increases the economy’s exposure to external shocks, in the form of exogenous changes in the foreign-currency prices of traded goods, remittance flows, and capital flows. Larger remittance flows, for instance, simultaneously magnify the channels of transmission from the international real economy to domestic aggregate demand.<sup>7</sup> Second, globalization may alter the trade-offs the central bank faces between competing objectives. Although most LICs remain poorly integrated with international financial markets, international financial shocks will increasingly pose challenges for central banks in LIC economies as well, especially in the form of destabilizing central bank objectives such as high levels of economic activity, stable exchange rates, and financial sector robustness. This will make the potential conflicts between such objectives and the central one of achieving medium-run price stability potentially more acute. Third, globalization may affect the monetary transmission mechanism in several ways (Abuka et. al. 2015; Montiel and Pedroni 2018). Much research has found a link between individual bank characteristics and the extent to which those banks tend to pass through changes in policy interest rates to their own retail lending rates.<sup>8</sup> More generally, globalization may also affect the relative merits of alternative exchange rate and monetary policy regimes in LICs. For instance, a larger traded goods sector increases the effectiveness of fixed exchange rates in importing anti-inflation credibility, because a larger share of the domestic price level is directly affected by international goods arbitrage.

# 3. Stylized facts: Evolution of inflation in LICs

Data for two periods are examined: 1980-99 and 2000-16. In both periods, LICs, like other EMDEs, generally experienced higher levels and volatility of consumer price inflation than did advanced economies (Figure 1). This is true of headline, core, food, and energy price inflation. The level and volatility of inflation declined between the two periods in each of the three groups, but the level and volatility of headline and core inflation in LICs remained generally higher than in advanced economies. Median headline inflation in LICs was around 6 percent in 2000-16, three times median inflation in advanced economies. Inflation performance in LICs has improved markedly over the past three decades but the decline happened later (starting in the 1990s) than in advanced economies (starting in the late 1970s).<sup>8</sup> Inflation volatility in LICs has also declined in recent decades (except food price inflation). This decline in volatility is not simply the result of the decline in median inflation among LICs: the cross-country correlation between the level of inflation and its volatility has tended to be much

> 8 See, for instance, Ha et al. (2019) on the evolution of inflation in low income countries.

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