On the contrary, new barriers could be erected either in the form of capital controls or through national regulations forcing financial  BIS Review 76/2010  11  institutions to ring fence local pools of capital and liquidity. There would be little convergence in domestic financial systems and regulations. Foreign exchange reserves would keep growing, both in absolute and in percentage of world GDP. This scenario may be seen as the only realistic response to increased diversity in a multipolar world. Such an evolution could also be defended on the ground that the assumed benefits of financial harmonization and integration have not really materialized (Rodrik et al. 2008). Furthermore, the crisis has shown that no financial system can claim to be intrinsically superior and countries could feel justified in adopting and promoting their own models. The systemic consequences, however, are not clear. In such a world, current account imbalances would be heavily influenced by public actions and policies. Regulatory competition would dominate the localization of financial activities and the allocation of savings. In the absence of some “rules of the game”, tensions would naturally arise between countries, most likely through conflicts about exchange rate regimes and policies. An opposite scenario would see the progressive opening of all capital accounts, together with some (more or less intensive) convergence in financial systems and regulations. This would allow for the emergence of a unified world capital market, an efficient allocation of savings across countries and a smooth financing of current account imbalances.

This matters because the size and nature of pass-through is likely to depend on the monetary policy regime. Moreover, pass-through from changes in the exchange rate to import prices, and then to consumer prices, has varied considerably over time. As my fellow MPC member Adam Posen pointed out recently, a range of studies suggest that exchange rate passthrough declined during the period of Great Stability (Posen 2010). Even ex post, the impact of the depreciation on consumer prices is hard to assess. The peak impact of the exchange rate depreciation on CPI inflation was probably somewhere in the range of 2 to 3 percentage points. While the scale of the total pass-through to retail price inflation appears broadly similar to past experience, companies seem to have passed through increases in import cost more quickly than in the recent past. 3 That quicker passthrough is likely to help explain why inflation over the past year or so has been higher than the MPC had anticipated. What evidence is this based on? The production of goods (excluding energy) tends to be more import-intensive than that of services, so the relative trends in goods and services price inflation can help to assess the impact of the depreciation on consumer prices. Between 1997 and 2008, annual non-energy industrial goods price inflation averaged around 6 percentage points lower than services price inflation. But that wedge closed during 2009, as non-energy industrial goods price inflation soared and services price inflation fell to below its historical average (Chart 1).