christian noyer : inflation, financial innovation and monetary policies – some contemporary challenges speech by mr christian noyer, governor of the bank of france, at the gic and cepii conference, paris, 13 may 2008. * * * inflation pressures are now at work in most parts of the world. today, i would like to start with offering some comments on this worrying development and then elaborate on the challenges raised by financial innovation for monetary policies. the current rise in global inflation appears in stark contrast with the price stability recorded over the past decades. during the last twenty years, globalisation has made a significant contribution to price stability. with new large players ( such as china and india ) entering the world economy, cheap imports of manufactured goods have become available to developed countries. the fall in import prices has allowed real consumption wages to grow without impacting real production wages. this, in turn, has lowered the inflation rate for any given level of employment. in parallel, the effects of globalisation have been felt more indirectly through increased competition, both on products and labour markets. inflation dynamics have also changed. maybe the most documented and commented - on of these changes has been the so - called flattening of the phillips curve. this, in economic jargon, means that domestic inflation has become less sensitive to the domestic output gap, or, alternatively, that it has become more stable during the business cycle. there are several possible – and not mutually exclusive – explanations for this phenomenon. expectations may be more solidly anchored, which would lessen the impact of the output gap on current inflation. it is also possible that, as a result of structural reforms, the nairu has decreased in many countries in recent years, thus giving the " optical " impression of a horizontal phillips curve during this period. in a broader sense, globalisation itself may also be responsible for the flattening of the phillips curve. in an open economy, domestic demand changes can easily be satisfied through increased imports. as a consequence, domestic inflation may become less sensitive to the domestic output gap and more sensitive to global tensions on production capacities. overall, these developments have made it easier for central banks to bring down inflation without real costs to the economy. but it is clear, today, that these effects are being reversed. the prices of oil, food and other commodities are now increasing fast. there might be three reasons for this rise ( the importance of which is currently hotly debated ) : first a supplydemand im

state that the euro will be the currency of the european monetary union as from the 1. 1. 1999. as a consequence, the national currencies, in particular notes and coins, will continue to circulate during a transitional period, as subdivisions of the euro. two other key elements are that the changeover will ensure the continuity of existing contracts denominated either in national currencies or in ecu and that the ecu will become the euro at a rate of 1 to 1. besides legal security, emu will reinforce monetary stability in europe. the maastricht treaty provides for a monetary framework very similar to that prevailing in germany and in france. the primary objective of the european system of central banks ( made up of the european central bank and national central banks ) will be price stability. the ecb council of governors ( only those of countries participating in monetary union ) will decide independently the level of official interest rates. representatives of the european council may attend the ecb council meetings, but they will not participate in the voting procedure. monetary union will be characterized by a single monetary policy and national fiscal policies. in this context, the issue of fiscal discipline and coordination is crucial. sound fiscal policies will help the escb to maintain price stability. coordinated fiscal policies will contribute to a balanced policy mix in europe. fiscal discipline will prevent free - rider strategies by countries running large deficits and raising funds at low interest rates, thanks to the credibility and stability of other countries. this question of european fiscal discipline is important in the context of the main criticisms which are presently enumerated, particularly from outside europe, in the analysis of the concept of emu. without being exhaustive in this listing, i personally see four major criticisms : first, it is sometimes argued that emu will lead to greater rigidity, in diverting attention from the necessary structural reforms and inducing an inward - looking posture over europe at the very moment when global competition is of the essence. secondly, the difficulty of delivering an appropriate “ policy - mix ”, the monetary policy being by definition concentrated in the hands of the ecb and the escb when, at the same time, the absence of a federal government and therefore of a federal budget leaves the fiscal policy of the union in the hands of 15 different governments. thirdly, the difficulty of absorbing “ shocks ” in a particular member economy, whether this shock is of a domestic or an external nature. this difficulty stems in particular from the absence