Transcripts of the monetary policymaking body of the Federal Reserve from 2002–2008.

Why don’t I give an overview? Then Steve can speak a bit about where we think we are. The topic has obviously become of great interest. It’s cropping up in any number of places, including the BIS. When we think about it, the first problem we confront is that we were never able in the simpler world of ten years ago or so to get Phillips curves that were the least bit acceptable for almost any foreign industrial country you could name. There was always great tension in international meetings, in research efforts, in conversations that we would have with central bank staff in some of these countries, and so forth to reconcile the way we thought about inflation and the forces driving inflation because they didn’t think in terms of slack and price pressures. If you go back far enough, obviously they had a lot of faith, somehow, in money growth or medium-term things. The OECD has tried often—indeed, people on my staff have tried often— to identify roles for gaps, in many of the European countries anyway. These things we call speed effects—which indicate that what matters is how fast you’re changing (not whether you have a lot of slack in resources but how quickly are you closing that gap)—always seemed to loom large in certain countries, and effects of gaps were very hard to find. For example, the whole period of Japanese deflation defies explanation in terms of a Phillips curve that has any kind of reasonable properties, or the deflation would have gotten worse and worse and worse over a long period of time, and it did not. So you’re starting from a world in which the links between capacity as we normally think about it and inflation were never strong and never commonly shared across a range of countries.

Now we add a level of complexity in that we have a more-globalized economy. We have had what amounts to a big, positive supply shock of labor, at the very least via the China-India- former Soviet Union line of reasoning, and suddenly people are now making arguments and estimating equations in which a global capacity measure is behaving better than I could ever find individual capacity measures to apply in these countries. It leaves me in a bit of a quandary.

I was in Basel over the weekend. The BIS released its annual report in time for its annual general meeting, and I was lucky enough to find myself seated at lunch next to the authors of some of the work. I said, “You know, I can’t imagine a variable that really captures what I think of as the range of effects that something like China might have and China’s labor force might have on the process of pricing in the global economy. You have this paper that you’ve written, and it’s reflected in the annual report, and you have five different measures . . .” He basically replied that they haven’t solved that problem and that the measures they used, in and of themselves, could readily be criticized, but they got some results. He swore to me that they had beaten on this equation with every possible negative rationale that would explain it other than being valid, and it still kept coming back at them as though something was there.

So I guess I am prepared now to look a little harder and try some of this ourselves, which we have been pretty skeptical about doing. But there’s a big gap between the notion that there are 800 million Chinese who might potentially be engaged in global economic activity and the reality of what’s determining prices in real time today. The fact that these people are potentially there but are nowhere to be seen other than in the rural areas of China, growing their own food, just makes it very difficult to think that one has captured something.

So I am certainly sympathetic with the notion that there are key bottlenecks—there are some features through the commodity markets or there are some other aspects within manufacturing in particular sectors where you see global capacity effects. But disentangling the relative price pieces of this story from something that might relate to the interaction of overall capacity and inflation is very, very difficult. I think we’re just beginning to do that. In terms of this outlook, Steve may want to make a few comments about where we think we see global growth and how that might matter.

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