The Importance of Global Shocks for National Policymakers: Rising Challenges for Central Banks

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about inward-looking versus outward-looking monetary policy and commitment versus
discretion, respectively.

The Chicago School saw a flexible exchange rate as a way of insulating domestic
developments from foreign economic disturbances, including foreign monetary policy.
There is no need, they argued, for central banks to coordinate their monetary policies. All
that is needed is flexible exchange rates. Does the existence of global liquidity mean that
we need coordination or even a world central bank? International coordination might be
needed to keep global liquidity shocks as low as possible, since structural changes
between global and national liquidity cannot be influenced by central banks. One reason
is that monetary competition between central banks might cause a free-rider problem
without any coordination. If a national central bank, let’s say the Bank of Japan, is
inclined to conduct a lax monetary policy, liquidity spillovers occur and foreign central
banks have to bear parts of the burden. Another reason is that there may be multiplier
effects that occur when several countries all turn their monetary policy in the same
direction. The crucial issue is how best to prevent further excessive, synchronized shifts
in the world money stock. However, policy coordination would bring greater
predictability, but at the risk of all countries simultaneously choosing the wrong set of
policies. International policy coordination would merely elevate to the global level the
shortcomings that are now apparent at the domestic level.

While we have come up with some additional empirical evidence supporting the
view that monetary policy has become less effective as a consequence of globalization,
the question remains unsolved whether central banks need to adapt their monetary policy
strategies in order to cope with the challenges of globalization. We leave this task for
further research.

References

Alessi, L. and C. Detken (2009): ‘Real Time’ Early Warning Indicators for Costly Asset
Price Boom/Bust Cycles - A Role for Global Liquidity, ECB Working Paper Series
1039, European Central Bank, Frankfurt/Main.

Artis, M. and T. Okubo (2008): Globalization and Business Cycle Transmission, CEPR
Discussion Papers 7041, Centre for Economic Policy Research, London.

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