Speech

The story in the advanced countries is well known and has been widely discussed: inflation averaged 9% in the first half of the 1980s, versus 2% since the beginning of this decade. But the performance of the developing countries is even more remarkable, with inflation falling from a 1980-84 average of 31% to an average of under 6% for 2000-03. From 1990-94, inflation in Latin America averaged over 230%, over 360% in the Transition economies, and roughly 40% in Africa. For 2003, all three regions are projected to have inflation around 10%.

The data are even more stunning when one looks at individual countries. In the 1970s, 1980s and 1990s, high inflation and hyperinflation countries 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 almost 10 quadrillion.² Today, of the IMF's 184 member states, only 11 are projected to have inflation over 20% in 2003, and only 6 over 30%. If one takes the 40% inflation threshold that some researchers have argued is particularly damaging to economic growth³, only Mynamar (40%) Angola (over 75%) and Zimbabwe (over 400%) seem reach or exceed this level in 2003.

The first section of the paper, in addition to documenting the broad global trend towards lower inflation, 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 is better anchored? I find mixed evidence in favor of this view for industrialized countries and, to a lesser extent, for emerging markets. The global economy now appears immersed in a long wave of low inflation, but experience suggests that many factors, notably heightened conflict that reverses globalization, can bring it to an end.

The second section looks at what forces might have been driving the disinflation process. There is little controversy about the fact that improved central bank design has been a major factor in improved inflation outcomes, and I will not try to parse the different elements (greater independence, better communication strategies, improved techniques, etc.) here. My main focus is 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 than would otherwise have been the case. Has the success of global monetary authorities in engineering lower inflation had anything to do with having the wind at their backs?

Fiscal policy is the first place to look. Since the invention of money, pressure to finance government debt and deficits, directly or indirectly, has been the single most important driver of inflation. Overall, the data suggest that improved fiscal policy is important for some regions, notably Latin American and Africa. The same is true for industrialized countries, less so if one takes into account the worsening demographic profiles for most of them. However, while greater fiscal rectitude has clearly supported disinflation in some regions, it hardly qualifies as a universal explanation. Many emerging markets and developing countries have seen public debt increase sharply relative to income over the past fifteen years.⁴ Another factor that is sometimes cited as contributing to disinflation, is the technology revolution. The productivity story neatly fits the US experience of the second half of the 1990s but the generalization to other regions, e.g., Europe, is far from obvious. Nor does technology explain the full recent history of disinflation, even in the United States, which began already under Paul Volcker in the early 1980s.

Instead, I shall argue that the most important and most universal factor supporting world-wide disinflation has been the mutually reinforcing mix of deregulation and globalization, and the consequent significant reduction in monopoly pricing power. This increased competitiveness lowers the gains a central bank can reap via unanticipated inflation because it reduces the gap between the economy's monopolistically competitive equilibrium and the socially desirable competitive equilibrium. In addition, both theory and empirics suggest that more competitive economies have more flexible nominal prices, making any output gain the central bank could achieve by inflating smaller and more ephemeral . As I show in a very standard, stylized political economy model, it is easier to credibly sustain low inflation in a competitive economy than in a highly monopolistic one.

The concluding part of the paper briefly speculates on the risks of a return of inflation, despite recent improvement in central bank design and function.

I. THE NEAR UNIVERSAL FALL IN INFLATION

The global taming of inflation over the past decade -- two decades for most industrial countries -- is breath-taking. Different countries, facing vastly different institutional, political and historical circumstances have taken diverse routes to achieving lower inflation. The vast majority of countries have succeeded, and dramatically so.

A. Global inflation trends

Table 1 gives an overview of the twenty-five year period 1980-2004, providing GDP-weighted average inflation rates by major groupings of countries. Global inflation averaged 15% in the 1980s, with Latin America having far and away the highest inflation rates, rising from 82% in the first half of the decade to 186% by the latter part of the 1980s. Global inflation peaked at 30% in the first half of the 1990s, thanks to soaring inflation throughout the developing world. 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 can mask 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 had inflation below zero or above 10% in 1992 or (projected) 2003. (Countries with inflation rates between zero and 10 percent are omitted, but all countries are listed in Appendix table A1 for the years 1970-2003.) In 1992, 44 countries had inflation over 40%. 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 Mynamar, Angola and Zimbabwe are projected to have inflation over 40%. For actual 2002 data, only half a dozen countries had inflation over 40%⁶, a far cry from the 44 seen in 1992. If one lowers the bar to 30%, this adds only four more countries for 2003-- Haiti, Venezuela, Iraq and Myanmar. And only five more have inflation between 20% and 30%-- Turkey, Belarus, Ghana, Uzbekistan and Uruguay, for a 2003 total of eleven out of 184 countries with inflation over 20%.

Indeed, deflation arguably threatens more countries today than does very high inflation (over 40%). If one takes into account the well-known upward bias of the CPI (e.g., due to new goods and new retail outlets), and delineates deflation at .5% or 1%, deflation becomes a much larger category (See Figure 1).⁷

Figures 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 percent of countries (existing at any given time) with inflation between zero and 10 percent. In Latin America, the percent of low to very low inflation countries has risen from under 10% in 1980 to almost 80% in 2003. In the Middle East, only a third of countries had low to very low inflation in 1980, but today the percent is again over 80. In developing Asia, the rise is from under 20% to 70% (not including countries with deflation.) And for very high inflation (the heavy dashed line), the pattern is reversed.

B. 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, and several cross-country empirical studies support this notion. 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 has accumulated since the early studies by Okun (1971) and Logue and Willett (1976) were published. More refined measures of inflation volatility, and extension of the analysis to emerging market countries, yield similar results.⁸

To further investigate, we next test explore augmented Dickey-Fuller unit root tests for 18 industrialized countries, using monthly data for the years 1960-2003. For the full sample, one 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 countries, with Austria, Switzerland, Netherlands, Norway and Portugal appearing to be better characterized by a stationary process.

However, in the case of the G-7 economies, as Table 3 indicates, if one splits the sample in the early 1980s, the picture becomes more interesting. For the earlier period, with the exception of Japan, the null hypothesis of a unit root cannot be rejected for any of these economies at conventional levels of significance. However, without exception, one can reject this hypothesis for all the G7 countries over the 1981-2003 period, and at a fairly high level of significance. These results, while admittedly somewhat 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 anchored; when there is a shock to inflation, markets 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 of over which inflation has been stable is a relatively short one, as is clear enough from Figures 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 [see Figure 3].

II. FACTORS UNDERPINNING THE GLOBAL REDUCTION IN INFLATION

One view of the past fifty years is that the monetary authorities just got bamboozled by bad Keynesian theories in the 1960s and 70s. The great inflation of the 1970s and 1980s was the by-product 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 The global nature of modern disinflation suggests looking elsewhere.

A. Greater Central Bank Independence

Certainly, institutional innovations in establishing and strengthening central bank independence have played an important role in many countries 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, central to many indices, is the rate of central bank governor turnover.¹² Table 4 shows the turnover index by region for the sub-periods 1970-89, and 1990-99.¹³ For developing countries the turnover rate dropped sharply from the first sub-period to the second, signifying greater independence, with particularly marked improvements in Latin America and the Middle East.¹⁴ For the industrial countries, there is little change in this independence measure over the two sub-periods. However, a plethora of other information, e.g., 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.

More independent central banks, in combination with having central bankers who place a high weight on stabilizing inflation, has unquestionably played a central role in the overall reduction of inflation. The exact mechanism for inducing an appropriate weight on inflation versus output stabilization is a matter of some controversy.¹⁵ I personally would argue that there has been a shift in emphasis towards appointing central bankers with greater inflation focus and awareness, and arguably greater technical skills. Regardless, it is apparent that many different approaches have worked.

One way to better illustrate how the recent global disinflation has transcended narrow interpretations of monetary regimes is to look at inflation performance across exchange rate regimes. Figure 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 exchange rate regime. The Figure 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 including countries with inflation over 40% 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.

Disaggregation by major economic or regional grouping of countries, as illustrated in Figure 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 reducing inflation.

B. Tighter Fiscal Policy

Though institutional factors related to the conduct and design of monetary policy have unquestionably played a central role in the disinflation process in many countries, what other supporting factors might have helped?

Many countries improved their fiscal positions during the 1990s, not only in industrial countries, but also many African and Latin American countries. As Table 5 indicates, industrial countries averaged general government primary balances of 2.8% during the period 1990-2002 compared to -0.1% for 1970-1989. The picture is even better if one excludes the last two to three years, when activity was sub-par in most industrialized countries. The situation in many emerging markets and developing countries has been similar: the Latin American countries averaged primary surpluses of 1.3% versus -0.13% in the earlier periods; African countries had deficits of -1.6% from 1990-2003, but this was a considerable improvement over -3.4% from the pre-1990 period.

There are, of course, several 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% 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% of GDP and a debt/GDP ratio exceeding 150%, is actually experiencing deflation. More generally, as Reinhart, Rogoff, and Savastano (2003) document, many emerging market and developing country economies have seen a substantial buildup in market-based debt over the past fifteen years, due to various factors including financial liberalization (e.g., paying market interest on debt formally forced on banks at sub-market interest), lower tariffs and, in some cases, higher government budget deficits. Yet most of these economies have succeeded in lowering inflation.

One must also note that 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, 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.

C. 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 pressure on the central bank to inflate, both because fiscal positions will benefit (as mentioned above), 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.¹⁷ However, in its simplest form, 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, with inflation falling through most of the period, yet trend productivity growth declining as well. Indeed, as Figure 6 highlights, amongst the largest European economies, productivity growth slowed substantially in the second half of the 1990s, continuing the trend decline in the largest continental economies. In the developing world, productivity - especially in traded goods - probably has been a factor in many cases, though it is hard to separate it from globalization, which we will turn to next.

D. Globalization, Deregulation and Declining Monopoly Power

There is little question that in many economies, the mutually reinforcing effects of globalization, deregulation and widespread reduction of the role of government, have sharply increased competition, and lowered "quasi-rents" to monopolistic firms and unions. Blanchard and Philippon (2003), drawing on results from a broader OECD study of deregulation (Nicoletti et. al., 2000, 2001), argue that quasi-rents in the OECD have fallen steadily since the 1970s. An important element in the initial impulse was capital and goods market integration in Europe, which led to a process of shifting production to lower cost countries, just as today production is shifting towards 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, eventually bringing these countries to levels close to that of the United States, where de-regulation began a decade earlier. Deregulation began later in continental Europe, with significant movement in the 1990s, though this region still has higher regulatory barriers and barriers to entrepreneurship than the Anglophone countries (Nicoletti et. al., 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 .4 versus .15 according to estimates used in the IMF's April 2003 World Economic Outlook), but appear to have come down everywhere.

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

Trade with emerging Asia has certainly put downward pressure on the real cost of goods, that is, workers in most countries can now buy more with a given income than prior to globalization.¹⁸ Although China alone accounts for 5% of world trade, emerging Asia combined accounts for almost 20%. The exact quantitative impact of Emerging Asia's growing trade on global prices, however, is difficult to estimate, in part because there are large indirect effects in addition to the direct effects. For example, even though traded goods arguably only constitute at most 20-25% of US GDP (Obstfeld and Rogoff, 2000), sharp reductions in traded goods prices almost surely have spillover effects to other sectors. Many traded goods are intermediate goods (e.g., computers), and also there is some degree of substitution between various traded and non-traded goods.

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

E. 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 major element, can be used to provide microfoundations to the classic Barro-Gordon-Kydland-Prescott model of credibility and monetary policy. In these new renditions, the wedge between the monopoly level of employment and the competitive level (with the wedge being due to monopoly in both product and labor markets) is one of the central imperfections that may tempt the central bank to try to inflate to drive employment above its "natural" market-determined rate. As the wedge becomes smaller, there is less gain to unanticipated inflation, and central bank anti-inflation credibility is enhanced even absent any institutional change. As corollary, average equilibrium inflation falls. (See Obstfeld and Rogoff, chapter 10, for example, or Ireland (1996)) Thus, an increased level of competition in the economy - due either to globalization or deregulation - not only lower real prices of goods, but helps coordinate a lower inflation equilibrium in the economy as well.

There is a second, related, channel via which greater competitiveness reduces any incentive the central bank might have to inflate, which is by making prices more flexible (at least according to a large theoretical and empirical literature). In very competitive markets, like agriculture, or semi-conductors, prices are enormously flexible, while in highly unionized sectors with a small numbers of industries, they tend to be much less so. The more flexible prices, the less potent monetary policy is in impacting the real economy. Rather ironically, with less gain to unanticipated inflation, a monetary commitment to low inflation becomes more credible. Certainly, especially if one looks across individual economies, many other factors affect the credibility of anti-inflationary policy, including debts and deficits as we have already discussed above. But the recent era of de-regulation and globalization has made increased competition a universal factor in the disinflation process internationally.¹⁹

Globalization and increased openness also harden a central banks' anti-inflationary resolve through a third, though closely related, channel. Because unanticipated monetary expansion tends to depreciate the exchange rate (in theory, at least!), this tempers the incentives of monetary authorities in more open economies to inflate. Exchange rate depreciation implies that any given level of inflation stimulus impacts inflation more, and employment less (due to wage indexation and higher costs of intermediate goods) than would be the case in less open economies (see Rogoff, 1985 and Romer, 1992; the latter provides cross-country empirical evidence).

In sum, globalization, acting synergistically with deregulation, not only puts downward pressure on real prices, but it also reduces any incentives central banks may have to engage in unanticipated inflation, thereby also leading to less nominal price inflation over the long run.

F. A Simple Mathematical Formalization of the Effects of Increased Competition on Equilibrium Trend Inflation

Though many readers will be quite familiar with the Barro-Gordon model of inflation, a very limited mathematical digression might nevertheless be useful. Assume a very simple world in which the central bank directly sets the inflation rate, π. The private sector makes decisions - including setting nominal wage and price contracts that embody expectations π^e about what the central bank will do. Output, in turn, is an increasing function of π - π^e. The private sector guesses right about inflation on average, despite the fact there is a wedge k between the socially optimal rate of output and the market-determined rate of output. In the original Barro-Gordon formulation, the authors appealed to income taxation as one factor that might create such a wedge, but newer formulations that derive the whole setting from microfoundations, stress that this wedge is inversely proportional to the degree of monopoly power in the economy. Overall, in the simplest static formulations, and ignoring institutions and credibility (the subject of much literature), the central banks' objective function is given by

(π - π^e - k - z)² + χ(π - π^*)²

where the first term is meant to capture the central banks' desire to stabilize output around its natural rate (assumed proportional to π - π^e - k - z ) and where z is mean zero productivity shock, π^* is the central banks' preferred rate of inflation (say 2.5%), and χ is the weight (priority) it puts on inflation stabilization versus output stabilization. As is well known, if private agents are rational and understand the central banks objectives, then the expected inflation rate will be

π^e = π^* + k/ χ

The actual inflation rate the central bank will select is

π = π^* + (k - z)/ χ

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 (e.g., 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 - making the wedge k smaller, and leading expected inflation to fall permanently. The reduction here is not coming because monopoly prices are higher than competitive prices, as in the usual discussion in the popular press. That is, the relative price effect which need not have any effect on inflation unless the central bank so chooses. Rather, the smaller wedge systematically lowers the central banks' incentives to inflate, so that it will, on average, choose a smaller π. 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 π^* is too low (and so too could a demand shock in a richer model).

Indeed, newer micro-founded models in the genre suggest that reduced monopoly will have a further effect, so that we can reformulate the central banks' objective function as

[μ(π - π^e) - k - z]² + χ(π - π^*)²

where μ is inversely proportional to the degree of price flexibility in the economy, and now equilibrium expected and actual inflation are given by

π^e = π^* + μ k/ χ and π = π^* + μ (k - z)/ χ

Higher μ implies that there are greater proportion of inflexibly priced goods in the economy, leading to a greater temptation to inflate. Since an increase in competitiveness also decreases μ in addition to k, this strengthens the argument that greater competitiveness makes anti-inflation policy more credible. The basic point here generalizes to virtually all the many variants of the Barro-Gordon model, and in principle to more dynamic models as well, as long as imperfect monetary policy credibility is an issue, as I, for one, believe it always will be.

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

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

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

G. Reduced conflict

Though the modern era has witnessed a number of peacetime inflations, war or civil conflict has caused many of history's high inflation episodes. We already see this in Figure 3 for the G7 countries with spikes during World War II and its aftermath, and then the 1970s round of inflation that was sparked at least in part by Vietnam-era US budget deficits. If the data were extended back to World War I, the effect would be even more dramatic. Many of today's few remaining high inflation countries labor under a legacy of conflict, and to the extent that new very high inflation countries appear over the next year or two, conflict is likely to be one of the major reasons. 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 9/11 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, de-regulation and a reduced role of government in the economy and, perhaps most importantly, 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 anytime 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 de-regulation have been powerful forces supporting the political economy of low inflation. Indeed, the most likely scenario is that these engines of higher competition and productivity will only continue to strengthen in coming decades. But long reversals are possible. After all, globalization was also a dominant theme in development in the 19^th century, but the process came to an abrupt halt and was even reversed for the four decades following the outbreak of the First World War. As already noted, conflict similarly 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 be a huge 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, a likely result from the resulting political and economic dynamic would be a partial resurgence f domestic monopoly power for firms and unions in many countries. This would partially reverse the process of the past two decades, leading to greater price inflexibility, and greater pressures on the central bank 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 today's low inflation, of course, would be a reversal of the modern trend towards 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, today's 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 rollback the extraordinary achievement of recent years.

Table 1. World CPI Inflation

(Percent per annum)

Table 3. P-Values of Unit Root Tests for G7 Countries¹

Table 4. Average Central Bank Governor Turnover Rate

(Fraction per five years)

Table 5. General Government Balances

(Fiscal balances as a percent of GDP)

Table A1. Inflation in the World Economy, 1970-2003¹

(Percent per annum)

Figure 2a

Figure 2b

Figure 3

Figure 4

Figure 5

Figure 6

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