This essay will assess research into the impact of globalization on inflation and discuss whether it has weekend the ability of central banks to control the dynamics of inflation. The ability of central banks to control the rates of inflation may be substantially complicated by the increased globalization of the goods markets, factor markets and the financial markets (Woodford, 2007). The ability of national banks to influence the dynamics of inflation through monetary policy may be undermined by globalization. The central bankâ€™s primary goal is to maintain price stability by regulating the level of inflation through monetary policy. Globalization increases trade both within and across countries (Schwerhoff & Sy, 2013). Through communicating their policy intentions regarding the future short-term interest rates, central banks can affect also the current longer-term rates (Tang, 2011). The new consensus (DSGE) Model incorporates four components, the output gap equation, the Phillipâ€™s curve, the exchange rate equation and the Policy Rule (Woodford, 2007). The policy rule incorporates the Taylor rule which stipulates the amount a central bank should change the nominal interest rates in response to changes in inflation, output or other economic conditions. It also incorporates the idea of the inconsistent trinity, (sovereign monetary policy, fixed exchange rate and free capital flow) where only two of these can be possible at any given time. The impact of globalization on the effectiveness of monetary policy is now at the center of international macroeconomics literature with the recent experience of inflation accelerating the large number of industrial and emerging market countries (Ã–zatay & Ã–zmen, 2008). They support the idea tha... ...lely on their domestic economy (The Economist, 2005). Even though this may suggest that globalization has been able to combat the nature of inflation mistakes by central banks could allow it to break out again. (The Economist, 2005). This is partly due to the fact that a number of central banks make their decisions based on the actions of other central banks such as the Federal Reserve in the US (Rogoff, 2006). An example of this would be with number of Asian and oil producing countries will stabilize their currencies against the US dollar, which implies that the policies enacted by the Fed can still have an impact on global interest rates. (Fisher, 2006) Suggests that central banks should be conditioned on changes in foreign potential output and questions why, for instance, the output gap is calculated without taking into account the Chinese and Indian economies.
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