Reproduction permitted only if source is stated. 91-3 (Printversion) Non-technical summaryThe global dimension of inflation has become a popular theme for economic researchers in academia and central banks. It has been shown that inflation rates across countries strongly comove due to domestic inflation rates being determined, among others, by foreign or global common forces. China's role in these developments is, however, still somewhat unclear.The significance of China for the world economy has risen enormously over the past 20 years in terms of both GDP and trade. Observers have speculated whether (positive) demand effects in China and subsequent positive effects on international price developments (via rising export and commodity prices) or whether supply effects and subsequent price dampening effects (via declining import prices and competitive pressures) have dominated in the past and, hence, what the net effect of these developments was. The goal of this analysis is to examine empirically the role of Chinese supply and demand shocks in global inflation dynamics and to shed light on the transmission mechanism.We apply a structural dynamic factor model to a large quarterly dataset of 38 countries (including China) between 2002 and 2011 to analyze China's role in global inflation dynamics. We identify Chinese supply and demand shocks and examine their contributions to global price dynamics and the transmission mechanism. Our main findings are as follows. (i) Chinese supply and demand shocks affect prices in other countries significantly. Demand shocks matter slightly more over the sample period than supply shocks. Producer prices tend to be more strongly affected than consumer prices by Chinese shocks. The overall share explained of international inflation by Chinese shocks is notable (about 5 percent on average over all countries but not more than 13 percent in each region). (ii) Both direct channels (via import and export prices) and indirect channels (via greater exposure to foreign competition and commodity prices) seem to matter. (iii) Differences in trade exposure (overall and with China) as well as commodity exposure help explaining cross-country differences in price responses. Demand shocks matter slightly more than supply shocks. Producer prices tend to be more strongly affected than consumer prices by Chinese shocks. The overall share of international inflation explained by Chinese shocks is notable (about 5 percent on average over all countries but not more than 13 percent in each region); (ii) Direct channels (via import and export prices) and indirect channels (via greater exposure to foreign competition and commodity prices) seem both to matter; (iii) Differences in trade (overall and with China) and in commodity exposure help explaining crosscountry differences in price responses. Nicht-technische ZusammenfassungJEL classification: F41, E31, C3

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This paper assesses how globalisation has shaped the economic environment in which the ECB operates and discusses whether this warrants adjustments to the monetary policy strategy. The paper first looks at how trade and financial integration have evolved since the last strategy review in 2003. It then examines the effects of these developments on global productivity growth, the natural interest rate (r*), inflation trends and monetary transmission. While trade globalisation initially boosted productivity growth, this effect may be waning as trade integration slows and market contestability promotes a winner-takes-all environment. The impact of globalisation on r* has been ambiguous: downward pressures, fuelled by global demand for safe assets and an increase in the propensity to save against a background of rising inequality, are counteracted by upward pressures, from the boost to global productivity associated with greater trade integration. Headline inflation rates have become more synchronised globally, largely because commodity prices are increasingly determined by global factors. Meanwhile, core inflation rates show a lower degree of commonality. Globalisation has made a rather modest contribution to the synchronised fall in trend inflation across countries and contributed only moderately to the reduction in the responsiveness of inflation to changes in activity. Regarding monetary transmission, globalisation has made the role of the exchange rate more complex by introducing new mechanisms through which it affects financial conditions, real activity and price dynamics. Against the background of this discussion, the paper then examines the implications for the ECB's monetary policy strategy. In doing so, it asks two questions. How is the ECB's economic and monetary analysis affected by globalisation? And how does globalisation influence the choice of the ECB's monetary policy objective and instruments? The paper concludes that while globalisation has had profound effects on the world economy, it has not significantly impeded the ECB's ability to achieve price stability autonomously. Nonetheless, over shorter horizons, globalisation has changed monetary policy transmission and affected trade-offs between price stability and other goals, such as stabilising real activity and prices on the one hand and enhancing financial stability on the other. Large financial spillovers strengthen the case for more systematic recourse to additional instruments such as forward guidance and asset purchases. Spillovers may also imply a need for more active macroprudential policy to counter any unduly large effects that global factors may have on domestic financial conditions.