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World's rising interest rates boost risks

Inflation is a usual target of central bankers, but globalization complicates their work.

By Staff writer of The Christian Science Monitor / June 27, 2006

When Ben Bernanke and other Federal Reserve policymakers meet this week, they'll come armed not just with their own inflation-fighting resolve but with the backing of their peers around the world.

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From Britain and continental Europe to rising giants such as China and India, central bankers are marching in lock step and speaking from a common script. Inflation is their enemy, and they don't plan to lose.

On the face of it, there's nothing unusual about a tightening of money supply simultaneously in many nations. But this time around, the trend symbolizes the increasingly global terrain that policymakers must navigate.

By working together, they hope to nip inflationary pressures and wring out excesses from a world economy that is now in its fourth straight year of 4 or 5 percent growth. If they succeed, that expansion could continue apace.

But by working together, the risk of a policy misstep – tapping the brakes too hard – is also magnified. Stock markets, down globally over the past six weeks, have clearly signaled that worry.

"I think that's why we see the global response in the equity markets," says Michael Cosgrove, who writes The Econoclast, a capital-markets newsletter based in Dallas. "We have the three major central banks in the process of tightening at the same time."

The job of central bankers has always been a tricky balancing act. Open the money spigot too far and the result could be artificial growth in the form of spiraling prices – inflation. Tighten the spigot too much and economies shrink, which could lead to falling prices – deflation. A key question now is how globalization has affected growth and whether that dynamic is changing.

"The globalization of financial markets has direct implications for central banks," Sandra Pianalto, president of the Federal Reserve Bank of Cleveland, said this spring. As the forces of supply and demand become more global, it "will tie interest rates in any single country more closely to interest rates across the globe."

Many economists believe that globalization has generally been disinflationary so far. In other words, the rising flows of money, workers, goods, and services across borders have restrained the pace of price increases. For example: Hordes of workers in emerging economies have entered the global labor force, creating competition for jobs. That, in turn, has put pressure on companies in the United States and the rest of the developed world to boost productivity and offer smaller pay raises.

Now, however, these forces have largely played themselves out, some economists say. Robust global growth has driven up demand for basic commodities, from oil to copper, whose prices are now rippling into consumer products.

"The effects of globalization on domestic inflation need not ... be negative, especially in today's environment of strong global growth," Donald Kohn, a Federal Reserve governor, warned in a speech last week.