8 Kenneth Rogoff has agued that inflation becomes more responsive to domestic excess demand if price rigidities are reduced and the economy becomes more flexible as a result of increased competitive pressure induced by globalisation. The proposition that a measure of “global economic slack” rather than the domestic output gap is a more important determinant of domestic inflation pressure has been discussed extensively. This hypothesis, if valid, would imply that the slope of the short-term Phillips curve, which depicts the responsiveness of inflation to domestic excess demand, becomes flatter. 9 Thus, in a globalised world – so it has been argued – a much stronger monetary policy response would be required, other things being equal, to preserve price stability over the medium term in the presence of adverse shocks. But also in this regard there exists no robust empirical evidence or solid and convincing theoretical foundation to support the claim that a structural change has taken place. 10 Empirical estimates for the euro area do not show a significant change in the slope of the short-term Phillips curve. Furthermore, it would be misleading to interpret the recently observed low correlation between domestic output gaps and domestic inflation in some countries as a structural change in the short-term Phillips  6  See Kroszner (2007). 7  See Bean (2006a and 2006b). 8  See Rogoff (2004, 2006). 9  See Borio and Filardo (2007). 10  See Ihrig et al. (2007). BIS Review 9/2008  3  curves.

Second, the welfaremaximising weight to be attributed to price stability also increases when international risksharing is obtained by means of cross-border holdings of nominal assets (e.g. non-inflation indexed bonds), as inflation would seriously distort effective risk-sharing. These interesting arguments bring me to the second part of my presentation on the potential implications of globalisation for financial stability. III. Globalisation and financial stability  Let me now focus on the effects of globalisation on the functioning of financial markets and institutions and the potential implications of these effects for the performance of the central bank task of safeguarding financial stability. This issue is both important and topical as the pace of global financial integration has accelerated in recent years and as the ongoing financial market turmoil has clearly demonstrated. Financial globalisation involves the increasing integration of financial markets and the growing presence of cross-border financial institutions. Financial globalisation is often defined and measured by the extent to which countries are linked through cross-border financial holdings. A commonly used indicator of financial globalisation is the sum of countries’ gross foreign assets and liabilities as a proportion of GDP. The evolution of this indicator documents the impressive dynamics of financial globalisation since the mid-1990s, especially for advanced economies (and to a lesser extent for emerging markets and developing countries). [see Chart 5]. In the euro area alone, the ratio of the sum of foreign assets and liabilities to GDP increased from 190% in 1999, the year the euro was launched, to 280% in 2005.