Monetary and fiscal policy in the process of global integration

The global environment in which monetary policy persisted brings more challenges as a result of changes that started with globalization in trade and financial fields. Concerning the trade, over the years that preceded the crisis in many advanced economies the task of monetary policy in maintaining low inflation was easier through global disinflationary pressures associated with cheaper imported products. Analyzing further, things will probably be different as structural upward trend in commodity global prices becomes a dominant factor. Thus, monetary policy tasks are likely to become more difficult through this channel. As far as financial flows are concerned, capital inflows in developing countries, are likely to be structurally at higher level after the crisis, given the relatively better growth prospects, the expected rates of return, and macro fundamentals. The size and speed of these flows, however, can pose a significant challenge for the user and lead to dilemmas in terms of setting economic policies. Specifically, countries faced with large inflows can choose between indulging significant appreciation of the exchange rate, which can wear out the trading, or intervene in currency markets to limit the appreciation. However, in the latter case, under perfect capital mobility, the authorities will not be able to sterilize the intervention, leading to higher inflation. In turn, raising rates to combat inflation would only bring more capital inflows and it can be self-destructive. The emergence of these fluctuations suggests the need for new ways and opportunities for developing countries to cope with the challenges they face in large capital inflows. Macroeconomic adjustment policies to enable sustainable rate of expansion of aggregate demand with lower domestic interest rates may help to limit capital inflows. Macro-prudential measures can also be deployed to mitigate the risks in terms of financial stability, which are related to the surge in capital flows. All this will probably allow monetary policy to continue to focus on its key objective of maintaining price stability.