Globalization and Global Disinflation

Rogoff, Kenneth

Over the past 10 years, global inflation has dropped from 30 percent to 4 percent.1 Without question, a large part of this breathtaking drop in inflation has to be attributed to improved central bank institutions and practice: enhanced central bank independence, a greater prevalence of more conservative anti-inflation oriented central bankers, better communications strategies, and improved monetary control capabilities. Also, the greater awareness in central bank boards, and among politicians and the public that higher inflation is the wrong instrument to deal with deep-seated structural and fiscal problems has no doubt encouraged central bank efforts. Yes, central banks rightly deserve a lot of credit for todays low inflation rates, but do they deserve it all? Have tailwinds made the political economy of disinflation in the last decade or two easier than commonly recognized? Will factors that for a while may have been exceptionally supportive of anti-inflation efforts be reversed? Improved fiscal policy and the technology revolution are examples of such factors which are popular in many explanations of the recent disinflation trends. I focus, instead, on the increased level of competition-in both product and labor markets-that has resulted from the interplay of increased globalization, deregulation, and a decreased role for governments in many economies.

Obviously, since competition tends to drive down prices, such an interplay should have some direct impact on inflation. However, I argue here that the major influence of competition on prices works through the political economy process that governs long-term inflation trends. Competition not only tends to reduce the overall level of prices, but it also tends to make prices (and wages) more flexible. As a consequence, the real effects of unanticipated monetary policy become smaller and more transitory. Hence, there is less cause for central banks to inflate and less incentive for politicians to pressure them to do so. Perhaps no less important, output and employment tend to be higher in an economy with greater competition. This, too, undermines potential pressures on the central bank to inflate. The net effect of these reduced pressures is that the central bank's anti-inflation credibility is enhanced, and trend inflation falls.

In what follows, the discussion is mostly nontechnical. Toward the end of the paper though, I sharpen my central point with a small mathematical model. Technically adept but impatient readers may wish to turn immediately to section II. By no means is this the only model of how globalization may affect trend inflation. Dollarization, for example, in many emerging markets, forces inflation-prone governments to temper their behavior for fear of having residents flee to other currencies. Regardless, the remarkable breadth of disinflation's shadow and the sweeping range of countries it has touched strongly suggest that there must be deeper political economy causes at work than are commonly recognized.

Whatever the explanation of global disinflation, the raw data are stunning. In recent years, inflation around the world has dropped to levels that only two decades ago seemed frustratingly unattainable. If one takes into account technical biases in the construction of the CPI, as well as central banks' desire to maintain a small amount of padding to facilitate relative price adjustment and avoid deflation then, disinflation has already run its full course in most industrialized countries. In the developing world, if current trends persist-with the emphasis on "if"-inflation will be tamed within a decade. Can the current situation be regarded as stable into the indefinite future? Has the inflation process changed fundamentally?

The story in the advanced countries is well recorded: Inflation averaged 9 percent in the first half of the 1980s, versus 2 percent since the beginning of this decade. Far less well known is the remarkable performance of the developing countries, with inflation falling from an average of 31 percent in 1980-84 to an average of under 6 percent in 2000-03. Early in the 199Os, from 1990 to 1994, average inflation exceeded 230 percent in Latin America and 360 percent in the transition economies, while it hovered around 40 percent in Africa. Average inflation in all three regions is projected to approach single digits in 2003.

Along with the aggregate decline in inflation, outlier cases have virtually disappeared as well. In the 1970s, 1980s, and 1990s, episodes of very high inflation and hyperinflation abounded, especially in Latin America, Africa, and the transition economies. Argentina's price level has increased a 100 trillion times since 1970, Brazil's a quadrillion (thousand trillion), and the Democratic Republic of the Congo's 10 quadrillion.2 Today, only three of the 184 IMF members-Myanmar (40 percent), Angola (over 75 percent) and Zimbabwe (over 400 percent)-are expected to reach or pass the 40 percent mark, the threshold above which most researchers find inflation acutely damaging.3 Only 11 countries are projected to have inflation over 20 percent in 2003, and only six over 30 percent. Inflation at these levels is still problematic but a far cry from the problems of a decade ago.

The first section of the paper documents the broad global trend toward lower inflation and asks whether the time series properties of inflation have changed. In theory, inflation should be more stable at lower levels; but do the data in fact show it to be better anchored? The evidence in favor of this view for industrialized countries is mixed, and more so for emerging markets.

The second section takes a look at the forces that may have been driving the disinflation process. With little controversy that improved central bank design has been a major factor behind improved inflation performance, I make no attempt here to examine in depth the workings of its different components (greater independence, better communication strategies, improved techniques, etc.) Instead, I focus on whether other factors, such as more prudent fiscal policies, higher productivity growth, deregulation, and increased globalization may have also contributed to make disinflation both less painful and more successful.

The paper first turns to fiscal policy. Since the invention of money, pressure to finance government debt and deficits, directly or indirectly, has been the single most important driver of inflation. It is not at all clear, however, that improved fiscal policy has been the main driver of the recent disinflation. True, the data suggest that primary surpluses have risen (or deficits fallen) sharply in both Latin America and in Africa. But in other regions, the trends are more ambiguous. In the industrialized countries, primary surpluses had increased until the recent downturn; but if one takes account of the long-term fiscal implications of deteriorating demographic profiles, the picture is at best mixed. Elsewhere, in many emerging-market and developing economies the public debt has increased sharply relative to income over the past 15 years.4

The next section of the paper examines briefly global productivity trends, another factor that is sometimes cited as having contributed to disinflation. While the productivity story neatly fits the U.S. experience of the second half of the 1990s, its generalization to other regions, for example, Europe, is far from obvious.

I then turn to discussing the political economy model of globalization, competition, and inflation alluded to in the opening paragraph of the introduction, including a small analytical model. The concluding part of the paper briefly speculates on the how likely it is that inflation might return in the foreseeable future, despite recent improvement in central bank design and function.

I. THE NEAR UNIVERSAL FALL IN INFLATION

We now turn to look more closely at the global taming of inflation over the past decade-two decades for most industrial countries. Different countries, facing significantly different institutional, political, and historical circumstances, have taken diverse routes to achieving lower inflation. The vast majority have succeeded, and dramatically so.

Global inflation trends

Table 1 reviews the 25-year period from 1980 to 2004, providing (purchasing power parity) GDP-weighted average inflation rates by major groupings of countries. Global inflation averaged 15 percent in the 1980s, with Latin America having far and away the highest inflation rates, rising from 82 percent in the first half of the decade to 186 percent by the latter part of the 1980s. Global inflation peaked at 30 percent in the first half of the 1990s, thanks to soaring inflation throughout the developing world, and especially in the newly formed transition countries. Even developing Asia, with its generally far more stable macroeconomic policies, had inflation going into double digits.

Since one or two very high or hyperinflation countries may bias the regional averages, it is helpful to break down the data by country. We proceed to do this in two ways. Table 2 lists all countries that kept inflation below zero or above 10 percent in 1992 or are projected to for 2003. Countries with inflation rates between 0 and 10 are omitted from this table, but all countries' inflation performance is given in detail in the Appendix table for the years 1970-2003. In 1992, 44 countries had inflation over 40 percent. While the transition countries accounted for just over half the total, the high-inflation group had representatives from every major region in the world in 1992.5 In 2003, as we have already noted, only Myanmar, Angola, and Zimbabwe are projected to have inflation over 40 percent, down from six countries in 2002.6

If anything, deflation threatens more countries today than does very high inflation (over 40 percent). Taking into account the well-known upward bias of the CPI (due, for example, to new goods and new retail outlets), and delineating deflation at .5 percent or 1 percent, deflation becomes a very large category (See Chart 1).7

Charts 2a-2b give a broader time series perspective on individual country inflation by developing country region since 1980. The thick, dark line in each of the charts gives the of countries, for the corresponding point in time, with inflation between O and 10. In Latin America, the of low to very low inflation countries has risen from under 10 percent in 1980 to almost 80 percent in 2003. In the Middle East, only a third of countries had low to very low inflation in 1980, but today the share is again over 80 percent. In developing Asia, the rise is from under 20 percent to 70 percent (not including countries with deflation.) The pattern is reversed for very high inflation.

Persistence

Virtually any plausible political economy theory of the inflation process suggests that low inflation ought to be a more stable state than high inflation. Several cross-country empirical studies support this hypothesis. For instance, Ragan (1994) showed a clear positive relationship between the rate of inflation and its standard deviation for 22 OECD countries over the period 1960-1989, confirming evidence which had accumulated since the early studies by Okun (1971) and Logue and Willett (1976). More refined measures of inflation volatility, and extension of the analysis to emerging-market countries, yield similar results.8

In augmented Dickey-Fuller tests, using monthly data for the period from I960 to 2003, we cannot reject the hypothesis of a unit root (loosely speaking, a random walk component) in inflation for any of the G-7 countries. The picture is slightly more mixed for smaller industrial countries. Inflation in Austria, Switzerland, Netherlands, Norway, and Portugal appears to be better characterized by a stationary process.

However, in the case of the G-7 economies, as Table 3 indicates, splitting the sample in the early 1980s, we obtain a more nuanced and more interesting picture. For all countries except Japan, we fail to reject the unit root hypothesis in the early period of the sample. In contrast, we can reject this hypothesis for all the G-7 countries without exception for the 1981-2003 period, and at a fairly high level of significance. These results, while admittedly sensitive to the choice of breakpoint, are broadly consistent with the view that during the 1970s inflation was adrift; whereas in recent years, expectations have become better anchored. When there is a shock to inflation, markets now expect that it will eventually dampen out. That view is also corroborated by survey data and expectations derived from inflation-indexed bonds. These suggest that inflation in many industrialized countries has become more firmly anchored in recent years and less sensitive to fluctuations in short-term inflation movements.9

For most developing countries and emerging markets, the time period over which inflation has been stable is a relatively short one, as is clear enough from Charts 2a and 2b. For the small number of developing countries for which a moderately long stable-inflation period is available, it is possible to test for increased stability in a manner analogous to our approach for industrialized countries. For emerging-market countries such as Chile, Israel, and South Africa, the results support the view that inflation over the recent period is mean-reverting; if inflation spikes, agents should expect the effects to fade away.

Of course, one cannot read too much into tests based on a relatively limited time period-even a few decades-given the historical evidence that inflation cycles tend to run in very long waves (Chart 3).

II. FACTORS UNDERPINNING THE GLOBAL REDUCTION IN INFLATION

One view of the past 50 years is that the monetary authorities just got bamboozled by bad Keynesian theories in the 1960s and 1970s. The great inflation of the 1970s and 1980s was the byproduct of macroeconomic teaching malpractice. Once the world's central bankers started coming to their senses in the 1980s, ending inflation was just a matter of communication and technique.10 Perhaps; but this interpretation probably gives too little credit to previous generations of policymakers and too much credit to modern day monetary authorities, not to mention 1980s monetary theory.11 Academic economists, for example, remain widely divided on the magnitude of the costs of inflation once below, say, 10 percent. Are we really so sure that 2 percent is dramatically better than 3 percent or 4 percent? How did Japan become mired in deflation for the last five years if we have it all figured out? I fully agree that improved institutions and more sophisticated policymakers-not to mention a more sophisticated public-have played pivotal roles. Still, the fact that inflation has fallen everywhere-even in countries with weak institutions, unstable political systems, thinly-staffed central banks, etc.-invites us to open our minds to the possibility that other factors have also been significant. But I begin by showing that central bank independence does indeed seem to have been on the rise throughout the world; there is a solid core of truth to the conventional wisdom.

Greater central bank independence

A number of academic studies attempt to measure central bank independence (see, for example, Berger, Eijffinger, and de Haan (2001) for a survey), though most aim at comparing independence across countries rather than across time. One widely used statistic, key to many indices, is the rate of central bank head turnover.12 Table 4 shows the turnover index by region for the subperiods 1970-89, and 1990-99.13 In developing countries the turnover rate dropped sharply from the first subperiod to the second, signifying greater independence. Latin America and the Middle East recorded particularly marked improvements.14 In the industrial countries, there is little change in this independence measure over the two sub-periods. However, a plethora of other information-for example, the granting of legal independence to the Bank of England and the Bank of Japan, not to mention the creation of the ECB-suggests that even for these countries, institutional change has been deep and widespread.

It is more difficult to quantify odier trend changes in central banks. I would argue that there has been a shift in emphasis toward appointing central bankers with greater inflation focus and awareness, and arguably greater technical skills. Others believe that good performance requires very specific mixes of policies-for example, that certain narrow interpretations of inflation targeting work much better than other policies. Skeptics, however, can point to the fact that many different approaches appear to have worked.15 One way to illustrate how the recent global disinflation has transcended narrow interpretations of monetary regimes is to look at inflation performance across different exchange rate regimes.

Chart 4 sorts countries' exchange rates regimes into five groupings according to the "Natural Classification Scheme" of Reinhart and Rogoff (2004). Loosely speaking, the Natural Classification scheme sorts countries' exchange rate regimes according to statistical measures of exchange rate movements, rather than according to the government's officially declared policies. Chart 4 is based on the "coarse" version of the Natural Classification, which groups countries in increasing order of flexibility as pegs, limited flexibility, managed floats, freely floating, and freely falling (the last category essentially includes countries with inflation over 40 percent or countries that have recently experienced an exchange rate crisis). As one can see, limited flexibility and freely floating currencies have the best inflation performance, but the gap is fairly narrow over the various categories except, of course, for freely falling.

Disaggregating by major economic or regional grouping of countries, as illustrated in Chart 5, yields a similar conclusion.16 Since the Natural Classification closely mirrors the monetary regime (most of the freely floating and managed floating countries look closely at domestic inflation in determining monetary policy), the fact that the exchange rate regime does not terribly impinge on inflation performance supports the view that there has been no "one-size-fits-all" approach to achieving and maintaining inflation.

Tighter fiscal policy

Many countries improved their fiscal positions during the 1990s, not only within the group of industrial economies but also in Africa and Latin America. As Table 5 indicates, industrial countries averaged general government primary balances of 2.8 percent during the period 1990-2002 compared to -0.1 percent for 1970-89. The picture is even better if one excludes the last two to three years, when activity was subpar in most industrialized countries (though, as already noted, if one incorporates the creeping costs of the demographic time bomb, the picture is less cheery). Emerging markets and developing countries have similarly succeeded in raising conventionally measured primary surpluses. The Latin American countries averaged primary surpluses of 1.3 percent versus -0.1 percent in the earlier periods. African countries had deficits of-1.6 percent from 1990-2003, but this was a considerable improvement over -3.4 percent from the pre-1990 period.

There are, of course, notable examples of countries where inflation has been coming down despite rising deficits and debt ratios. India has been recording general government deficits of roughly 10 percent of GDP for almost half a dozen years now, yet inflation has declined. Recession-ridden, post-1980s-bubble Japan, with sustained deficits of 6-7 percent of GDP and a debt/GDP ratio exceeding 150 percent, is actually experiencing deflation. More generally, Reinhart, Rogoff, and Savastano (2003) document that many emerging-market and developing-country economies have seen a substantial buildup in market-based debt over the past 15 years.17 Financial liberalization, (for example, paying market interest on debt formerly forced on banks at sub-market interest), lower tariff revenue, and, in some cases, higher government budget deficits, are some of the factors behind this trend. Yet most of these economies have succeeded in lowering inflation.

Also, whereas many industrialized countries experienced an improvement in their debt/GDP ratios during the 1990s, up until the 2001 recession, few countries made significant net forward progress on dealing with their retirement bulge, which has been creeping ever closer. For many countries, the imputed long-term fiscal effects of bringing the demographic shock one step closer each year is quantitatively a more serious problem than the typical year's budget deficit. On net, then, fiscal policy is likely to have been broadly supportive of the disinflation process, but outside of a couple of developing country regions (most notably parts of Latin American and Africa), fiscal policy cannot be considered a universal and decisive factor in the broad global disinflation we have documented in the first section.

Productivity growth and the Technological Revolution

Another plausible factor that might have helped support disinflation is productivity growth. Unexpected productivity growth at least temporarily reduces the pressure on the central bank to inflate, both because growth strengthens fiscal positions and because any short-term tradeoffs between disinflation and growth become more politically palatable. True, the productivity story works well for the United States since the latter half of the 1990s.18 In its simplest form, though, the productivity hypothesis falls far short as an explanation for global disinflation. In the case of Europe, for instance, the simple correlation goes the wrong way; inflation was falling through most of the period, while trend productivity growth was declining as well. Indeed, as Chart 6 highlights, productivity growth slowed substantially in the second half of the 1990s, continuing the trend decline among the largest European economies. In the developing world, productivity-especially in traded goods-probably has been a factor in many cases. It is hard, though, to separate its impact from that of globalization, to which we will turn to next.

Globalization, deregulation, and declining monopoly power

While, admittedly, hard evidence is still limited, the mutually reinforcing effects of globalization, deregulation, and widespread reduction of the role of government have no doubt sharply increased competition and lowered "quasi-rents" to monopolistic firms and unions throughout much of the world. Blanchard and Philippen (2003), drawing on results from a broader OECD study of deregulation (Nicoletti and others 2000, 2001), argue that quasi-rents in the OECD have fallen steadily since the 1970s. In that case, goods and capital market integration in Europe provided an important initial impulse. Production then was shifting to lower cost countries, just as today production is shifting toward the EU accession countries of central Europe.

During the 1980s, the speed of deregulation increased markedly in the United Kingdom, New Zealand, Australia, and Canada. It eventually brought these countries to levels close to that of the United States, where deregulation had begun a decade earlier. Continental Europe followed the deregulation bandwagon of the Anglophone countries, making significant progress in the 1990s. Still, this region has retained higher regulatory barriers and barriers to entrepreneurship (Nicoletti and others 2000, 2001). Markups of price over marginal cost-a standard measure of monopoly rents-remain much higher on the continent compared to the United Kingdom and the United States (about 0.40 versus 0.15, according to estimates used in the IMF's April 2003 World Economic Outlook). In developing countries, opening to trade has typically led to sharp drops in monopoly rents for domestic firms (often the strongest opponents of trade). Though far from always the case-especially where countries failed to put needed regulation in place-widespread privatization has increased competition as well.

A reduction in monopoly pricing power per force leads to lower real prices, holding monetary policy constant. Monetary authorities can, of course, suitably adjust monetary policy to offset such nominal price level effects. As I elaborate below, however, they will choose in general to let some of the effects pass on to lower inflation.

Of course, in parallel with the indirect effects stressed above, globalization can also have a direct impact on prices. Trade with emerging Asia has certainly put downward pressure on the real cost of goods; workers in most countries can now buy more with a given income than prior to globalization.19 Although China alone accounts for 5 percent of world trade, emerging Asia combined accounts for almost 20 percent. The simultaneous workings of direct and indirect effects make it difficult to assess accurately the quantitative impact of emerging Asia's growing trade on global prices. For example, even though traded goods constitute at most 20-25 percent of the U.S. GDP (Obstfeld and Rogoff 2000), sharp reductions in their prices are bound to create spillover effects on other sectors. Many of the traded goods are intermediate goods (such as computers), or, to some degree, substitutes for nontraded goods.

Does it matter if trade and deregulation increase competition and push down real prices? Isn't, after all, inflation about nominal price levels not real price levels? How can globalization lead to disinflation in countries where the central bank is not firmly committed to an exchange rate target and free to aim for its own domestic inflation target?

Increased competition and anti-inflation credibility

In recent years, a number of authors have pointed out that modern new Keynesian and New Open Economy macroeconomic models, where monopolistic competition is typically a crucial feature, can be used to provide micro foundations to the classic Kydland-Prescott-BarroGordon model of credibility and monetary policy. In this new analytical framework, monopoly in both the product and labor markets creates a wedge between the monopoly level of employment and the corresponding benchmark competitive level. Such an imperfection provides the crucial motivation for the central bank to inflate in order to drive employment above its "natural" market determined rate. As the wedge becomes smaller, there is less to gain from unanticipated inflation. Central bank anti-inflation credibility is enhanced, even without any institutional change. As a consequence, average equilibrium inflation falls?·® Thus, an increased level of competition in the economy-due either to globalization or deregulation-not only lowers the real prices of goods, but also tips coordination toward a lower inflation equilibrium.

A second closely related causal mechanism works from greater competitiveness to lower inflation through higher price flexibility. According to a large theoretical and empirical literature in very competitive sectors, like agriculture or semi-conductors, prices are significantly more flexible than in sectors that are highly unionized or have a small numbers of industries.21 Where prices are more flexible, the impact of monetary policy on the real economy becomes less potent. In turn, then, the lower gains from unanticipated inflation make the commitment of the monetary authorities to low inflation more credible.

Certainly, many other factors affect the credibility of anti-inflationary policy across countries, including debts and deficits, as we have already discussed above. And as noted in the introduction, my desire to isolate and formalize the effects of globalization on inflation leads perhaps to a narrower portrayal of the effect than is likely the case. Other channels outside the model, such as dollarization, are almost surely also significant.22

In sum, globalization, acting in synergy with deregulation and privatization, puts downward pressure on real prices and weakens the incentives that central banks may have to produce unanticipated inflation; thereby, it also leads to lower nominal price inflation over the long run.

A simple mathematical formalization of the effects of increased competition on equilibrium trend inflation

Since the productivity shock is zero on average, private sector agents are right on average about the inflation rate. Without going into further details-since there are many places to find related analyses (for example, Obstfeld and Rogoff 1996, chapter 9)-this short analysis allows me to reinforce a couple points. First, when globalization and deregulation make the economy more competitive, they reduce the wedge k, causing expected inflation to fall permanently. The decline in inflation here is not caused by the fact that monopoly prices are higher than competitive prices, as usually discussed in the popular press. The relative price effect need not have any effect on inflation unless the central bank chooses so. Rather, the smaller wedge systematically lowers the central bank's incentives to inflate, so that it will, on average, choose a smaller [pi]. A positive productivity shock has only a temporary impact on inflation and no effect in the long run, unless it affects the wedge k. Potentially, a large enough positive productivity shock can even throw an economy into deflation if target inflation [pi]* is too low. (In a richer model, a demand shock could produce a similar result.)

A higher [mu] reflects a greater proportion of inflexibly priced goods in the economy and a greater temptation to inflate. In such a setting, since an increase in competitiveness also decreases [mu] in addition to k, the argument that greater competitiveness makes anti-inflation policy more credible is strengthened.

The basic point made here generalizes to virtually all variants of the Barro-Gordon model. In principle, it may be generalized to more dynamic models as well, as long as imperfect monetary policy credibility remains an issue, as I, for one, believe it will always be.

Hopefully, this short mathematical detour has clarified some of the basic points made earlier:

(1) In thinking about trend inflation, what really matters is the central bank's incentives to inflate. Shocks to relative prices, which many confuse with inflation, are of secondary importance.

(2) Unexpected productivity (technology) shocks can lower inflation, but only temporarily. An explanation of the deeper trend must lie elsewhere, in factors such as greater competition or price flexibility.

Reduced conflict

Though the modern era has witnessed a number of peacetime inflations, it is war or civil conflict that has caused many of history's high-inflation episodes. We already see this in Chart 3 for the G-7 countries. Inflation spikes during World War II and its aftermath, and then again in the 1970s, sparked at least in part by Vietnam-era U.S. budget deficits. If the data were extended back to World War I, the effect would be even more dramatic. Many of todays few remaining high-inflation countries labor under a legacy of conflict; if new very high-inflation cases appear over the next year or two, conflict is likely to be one of the major reasons behind them. Though the 1990s witnessed many terrible wars, the overall situation was milder than in previous decades, especially for the larger economies. Of course, the post September 11 era has seen some rollback of the peace dividend of the 1990s.

III. WILL INFLATION COME BACK?

The huge success of monetary authorities around the globe in reducing inflation over the past decade owes much to more effective and independent central banking institutions, as well as to a generation of policymakers determined to establish and maintain low inflation. But the task has been made easier by a number of supporting factors, including relatively low debt accumulation, technological advances, deregulation, a reduced role of government in the economy, and, perhaps most important, globalization. It is clear that the relative role of these diverse supporting factors has differed across countries, but overall the global environment has been favorable. One central point of this paper is that increased competition in an economy not only has a one-off effect on relative prices, but through the political economy of the inflation process can lead to a sustained reduction in inflation rates.

Can inflation, which has been largely eradicated in the industrialized countries and is now being tamed if not exterminated in one developing country after another, make a comeback in the next decade or two? Though institutions and understanding are much improved, it is not hard to imagine that the present historical wave of low inflation, like others, will someday end.

For example, I have argued that globalization and deregulation have been powerful forces supporting the political economy of low inflation. These engines of higher competition and productivity will most likely continue to strengthen in coming decades, but long reversals are possible. After all, globalization was a dominant theme in development in the 19th century, too, but the process came to an abrupt halt and was even reversed for the four decades following the outbreak of World War I. As already noted, conflict has the potential to interfere with globalization in the modern era. An admittedly melodramatic example illustrates the point: If terrorist threats ever reach the point where ships entering, say, the United States, ever need to be searched and scanned like passengers in an airport, the resulting delays and frictions would deal a blow to the complex global supply chain, with both one-off and dynamic effects. If events forced sharp cutbacks in global trade for a sustained period, domestic political and economic dynamics would likely allow firms and unions to recover part of their monopoly power; one could envision then circumstances of greater price inflexibility with greater pressures on the central banks to inflate.

Also, while there are few countries today where fiscal policy is an immediate threat to monetary policy, it is not hard to find industrialized or emerging-market countries where debt levels are a looming problem. Countries facing immediate adverse demographic shocks are particularly at risk. Although old age retirement payments are indexed to inflation in most countries, some governments may still find that the easiest way to back out of unsustainable systems is via some combination of "surprise" de-indexing and inflation.

The greatest threat to todays low inflation, of course, would be a reversal of the modern trend toward enhanced central bank independence, particularly if trend economic growth were to slow, owing, say, to a retreat in globalization and economic liberalization. The favorable economic climate is also supportive of a favorable political climate. As long as central bank independence remains strong, and it is widely accepted that low inflation should be one of the central bank's main aims, todays virtual zero inflation can potentially be maintained for a long time. Still, overall, one must acknowledge that any pronounced or widespread relapses in the relatively favorable backdrop of globalization, deregulation, productivity increase, and relatively benign fiscal policies could begin to roll back the extraordinary achievement of recent years.

ENDNOTES

1 These figures are from the 2003 and 2004 average global inflation projections from the IMF's World Economic Outlook. Country inflation rates are weighted by PPP GDP weights (WEO).

2 See Reinhart and Rogoff 2002.

3 See Bruno and Easterly 1995.

4 See Reinhart, Rogoff and Savastano 2003.

5 In 1987, before most of the transition countries began to exit communism, 24 countries had inflation over 40 percent-far over 40 percent in many cases.

6 In 2002, Angola, Belarus, Iraq, Myanmar, Turkey, and Zimbabwe were the countries with over 40 percent inflation.

7 Chart 1 is based on Kumar and others 2003.

8 See for example Evans 1991, Brunner and Hess 1993, and Darrat, Franklin, and Lopez 1988.

9 A small number of other studies have looked at the time series evidence on whether inflation has become more stable in industrialized countries, including Pivetta and Reis 2003, Batini 2002, and Levin and Piger 2003.

10 Romer and Romer 1996, Blinder 1998.

11 It is easy to forget that the leading monetary theorists of the 1980s were ever so sure that their theories proved that any attempt at discretion in monetary policy would prove counterproductive-a dogma that has now been roundly rejected even by their most fanatic followers.

12 The low rate of turnover may not be a perfect proxy for central bank of independence-turnover of the membership of the central bank's policymaking committee is equally important-but it nevertheless appears to track the degree of continuity and independence reasonably well.

13 The underlying data used to construct Table 4 are drawn from Ghosh, Guide, and Wolfe 2003, and are also used by Tytell and Wei 2003.

14 An exception for transition countries where, evidently, there was relatively less turnover under communism!

15 Ball and Sheridan (2003) argue that inflation targeters have not necessarily reformed better than other central banks, either in achieving low inflation or achieving macroeconomic stability, with the supposed superior performance of inflation targeters deriving mainly from those countries with very weak starting points.

16 That pegged exchange rate regimes should perform relatively well in stabilizing inflation for developing countries should come as no surprise, especially since, in the construction of Chart 5, high inflation after the collapse of a peg is attributed to the post-peg regime.

17 See also chapter III of the September 2003 World Economic Outlook (IMF 2003b), that extends the analysis of Reinhart, Rogoff, and Savastano (2003).

18 See, for instance, DeLong 2002.

19 In passing, it is worth mentioning that global commodity prices were on a steady downward trend for much of the period since the 1990s, again providing a favorable environment for price reduction in commodity importing countries. Arguably, this factor may be more important than I am giving it credit here and bears further consideration.

20 See Obstfeld and Rogoff, chapter 10, tor example, or Ireland 1996.

21 See Taylor and Woodford 1999.

22 For example, globalization and increased openness also harden a central banks' anti-inflationary resolve through a third, interrelated channel. In theory, at least, an unanticipated monetary expansion would tend to depreciate the exchange rate. Such a depreciation would imply that a given level of monetary stimulus affects inflation more and employment (due to wage indexation and higher costs of intermediate goods) the more open the economy is. Openness, in other words, tempers the incentives of monetary authorities to inflate. (See Rogoff 1985 and Romer 1992; the latter provides cross-country empirical evidence).

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Kenneth Rogoff is a professor of economics at Harvard University. This paper was written while the author was economic counselor and director of research at the International Monetary Fund. This paper was presented at the Federal Reserve Bank of Kansas City's symposium, "Monetary Policy and Uncertainty: Adapting to a Changing Economy, " at Jackson Hole, Wyoming, August 28-30, 2003. The author is grateful to Mohan Kumar for many insightful comments and to Ken Kashiwase and Ioannis Tokatlidis for excellent research assistance. The views expressed here are those of the author and not necessarily those of the International Monetary Fund or the Federal Reserve Bank of Kansas City. This paper is on the bank's website at www.kc.frb.org.

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