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Global markets could swiftly punish central banks: US Fed
10/13/2005
WOOSTER, Ohio, Oct 12 (Reuters): Increasingly globalised financial markets may be less forgiving when they think central banks have erred than the domestic-based markets of the past, Federal Reserve Board Governor Donald Kohn said yesterday.
Kohn said growing integration in the world economy may help speed productivity growth and hold down inflation, but it had not made his life as a central banker any easier.
"To the extent that the US can more readily draw upon world capacity, the inflationary effect of an increase in aggregate demand might be damped," Kohn said in a speech at the College of Wooster in Ohio.
"But from another perspective, integrated economies and financial markets can also exert powerful feedback, which may be less forgiving of any perceived policy error," he said.
Kohn used as an example a hypothetical situation in which financial markets come to doubt the Fed's dedication to price stability, saying this would hurt investors' appetite for dollar assets and spark an inflation- boosting decline in the value of the dollar.
"The need to compete for business in a globalised economy has quite likely raised the efficiency and flexibility of economic systems as well as reinforcing the requirement for noninflationary monetary policies," he said in the speech.
In answer to audience questions later, he said underlying US inflation -- which strips out volatile food and energy prices -- had been "pretty well behaved" but that the Fed had been raising rates to maintain that status quo.
Kohn said the integration of emerging economies into global trade had put downward pressure on prices, but said the impact on US inflation likely had not been large. Kohn also warned that "the extent and duration of (globalisation's) damping influence on inflation are open questions."
The Fed governor also urged resistance to protectionist forces, saying: "If we put up barriers to trade ... everyone is going to be a loser."
Kohn -- often mentioned as a potential candidate to succeed Fed Chairman Alan Greenspan when he steps down early next year -- said it was "somewhat" surprising some developing economies, such as China, were running trade surpluses. But he said this would not go on forever.
During audience questions, the Fed official said continued rigidities in China's currency regime could impede the emerging powerhouse's ability to respond to economic shifts.
Kohn also said he would expect countries that have kept their currencies in check to eventually come to the view that greater foreign exchange flexibility would improve the functioning of their economies.
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