^*Mark M. Spiegel is Vice President, Economic Research, and Director, Center for Pacific Basin Studies, with the Federal Reserve Bank of San Francisco. Portions of this paper are adapted from a speech delivered at the Bank of Korea's 15th Annual Central Banking Seminar, "Increasing Capital Flows Among Countries and Monetary Policy," in Seoul, Republic of Korea, September 18–21, 2007. Helpful comments were received from Bob Flood, Galina Hale, Ayhan Kose, Andy Rose, and an anonymous referee. Christopher Candelaria provided excellent research assistance. All views presented in this paper are those of the author and do not necessarily represent those of the Federal Reserve Bank of San Francisco or Federal Reserve Board of Governors.

Abstract

The literature appears to have reached a consensus that financial globalization has had a "disciplining effect" on monetary policy, as it has reduced the returns from—and hence the temptation for—using monetary policy to stabilize output. As a result, monetary policy over recent years has placed more emphasis on stabilizing inflation, resulting in reduced inflation and greater output stability. However, this consensus has not been accompanied by convincing empirical evidence that such a relationship exists. One reason is likely to be that de facto measures of financial globalization are endogenous, and that instruments for financial globalization are elusive. This paper introduces a new instrument—financial remoteness—as a plausibly exogenous instrument for financial openness. It examines the relationship between financial globalization and median inflation levels over an 11-year cross-section from 1994 through 2004, as well as a panel of five-year median inflation levels between 1980 and 2004. The results confirm a negative relationship between median inflation and financial globalization in the base specification, but this relationship is sensitive to the inclusion of conditioning variables or country fixed effects, precluding any strong inferences.