As we consider the decision of policy rate normalization, we are mindful of possible spillovers to other economies, including emerging market and developing economies. In an interconnected world, fulfilling the Federal Reserve's objectives under its dual mandate requires that we pay close attention to how our own actions affect other countries and how developments abroad, in turn, spill back into U.S. economic conditions.

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In order to minimize the likelihood of surprises and thus avoid creating unnecessary market and policy volatility, we are striving to communicate our policy strategy clearly and transparently. Beyond communicating our intentions, we also emphasize that monetary policy normalization in the United States will occur in the context of a strengthening U.S. economy, which should benefit the emerging market and developing economies.

Still, one feature of the era after the first increase of the federal funds rate will, in all likelihood, be higher U.S. and global interest rates compared with their extraordinarily low levels of recent years. The increase in global interest rates could cause investors to adjust their portfolios, triggering capital outflows from emerging market and developing economies.

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Once we begin to remove policy accommodation, the Committee's assessment is that economic conditions will likely warrant raising the federal funds rate only gradually. Thus, we expect that the target federal funds rate will remain for some time below levels viewed as normal in the longer run. But that is only a forecast, and monetary policy will, in practice, be determined by the data--primarily data on inflation and unemployment.

For the moment, emerging Asia is offsetting weakness in external demand through accommodative monetary and fiscal policies. But ultimately, it would be desirable, both for the region and for the global economy, if emerging Asia were able to rely less on temporary policy stimulus and more on a fundamental rebalancing of growth toward domestic demand.

It is important not to take the wrong lesson from the finding that more open economies were more severely affected by the global recession.  Although tighter integration with the global economy naturally increases vulnerability to global economic shocks, considerable evidence suggests that openness also promotes stronger economic growth over the longer term.  Protectionism and the erecting of barriers to capital flows should thus be strongly resisted.

[F]inancial institutions are likely to have a larger global presence over time, and to be more active in financial derivatives. Both trends represent the normal outgrowth of globally integrated economies and financial markets, and are not necessarily unwelcome or unhealthy. But the critical point is that the roles and powers of supervisors and regulators have not kept up with these developments.

I expect the financial system to continue to involve a mix of capital markets and institutions, but with a wider array of institutions falling under regulatory supervision. Furthermore, I take it as given that there will continue to be large international institutions with operations in many countries, that is to say, regulatory jurisdictions around the globe.

Looking ahead, I see an ongoing role for securitization and the originate-to-distribute model. Securitization markets have shrunk dramatically over the last year and a half and in some cases have shut down altogether. I expect these markets to return, perhaps in simpler form and with more accountability.

Economists expect trade to decline during an economic slowdown. But the recent sharp contraction of trade appears to be far more severe than would be expected given the decline in global economic activity.

I believe some of the fall in international trade can be attributed to the disruption of the interbank credit system. The marked reduction of interbank lending appetite has been associated more with the market for short-term liquidity, but it also has affected trade credit. With the interbank liquidity crisis, banks have moved to reduce overall counterparty exposure including trade credit

Recent analysis of the size and sources of spillovers between the United States, the euro area, Japan, and other industrial countries finds a central role for international trade. But spillovers also occur through commodity prices and through financial variables such as short- and long-term interest rates and equity prices.⁷ For example, when liquidity conditions tighten in one country, globally active banks may attempt to pull liquidity from overseas affiliates, reducing the liquidity consequences at home but simultaneously transmitting the shock abroad.⁸ What is particularly interesting is that in some cases, financial linkages might now be more important for transmission than the traditional trade linkages. 

The evidence sometimes presented as indicative of a divergence in economic performance, referred to as decoupling, is not definitive. It is certainly the case that in recent quarters, the U.S. economy slowed to a greater extent than other industrial economies, and economic activity in the industrial economies, in aggregate, has slowed more than in the emerging market economies. This experience contrasts with that near the start of this decade, when the economic downturn of 2001 through 2002 was felt more uniformly throughout the global economy. In addition, financial conditions in most emerging market economies have remained relatively stable, considering the turmoil that overtook industrial country financial markets over the past year.

Even so, neither economic growth nor financial markets in the different regions of the world moved in lockstep in the past, nor are they expected to do so across all business cycles. It is far from clear that the divergences in performance we have seen of late, which are tentative in any event, represent distinct breaks from historical benchmarks. The recent divergences of economic performance reflect a particular set of shocks that have hit the global economy, as well as changes in the way that different economies have responded to those shocks.

Empirical work on inflation, including much of the classic work on Phillips curves, has generally treated changes in commodity prices as an exogenous influence on the inflation process, driven by market-specific factors such as weather conditions or geopolitical developments.  By contrast, some analysts emphasize the endogeneity of commodity prices to broad macroeconomic and monetary developments such as expected growth, expected inflation, interest rates, and currency movements.  Of course, in reality, commodity prices are influenced by both market-specific and aggregate factors...

I have only mentioned a few of the issues raised by commodity price behavior for inflation and monetary policy.  Here are a few other questions that researchers could usefully address:  First, how should monetary policy deal with increases in commodity prices that are not only large but potentially persistent?  Second, does the link between global growth and commodity prices imply a role for global slack, along with domestic slack, in the Phillips curve?  Finally, what information about the broader economy is contained in commodity prices?  For example, what signal should we take from recent changes in commodity prices about the strength of global demand or about expectations of future growth and inflation?

 From the U.S. perspective, this growth has been a double-edged sword.  On the one hand, low-cost imports from emerging markets for many years increased U.S. living standards and made the Fed's job of managing inflation easier.  Moreover, currently, the demand for U.S. exports arising from strong global growth has been an important offset to the factors restraining domestic demand, including housing and tight credit.  On the other hand, the rapid growth in the emerging markets and the associated sharp rise in their demand for raw materials have been--together with a variety of constraints on supply--a major cause of the escalation in the relative prices of oil and other commodities, which has placed intense economic pressure on many U.S. households and businesses.

Whether the economies of the rest of the world have successfully decoupled from the United States is a judgment we will have to leave to the economic historians. What I do believe, however, is that our financial markets at the center of this turmoil have not decoupled, not even a little bit. In fact, our financial institutions and financial markets have never been more integrated. Policy differences, thus, should not be taken lightly.

It used to be said that when the United States sneezes, the world catches pneumonia. A better metaphor for today would be that when the United States gets a cold, the world gets a cough and the sniffles.

My view is the following: Global economic integration has progressed in recent years to the point that a slowdown in the United States will unquestionably be felt, but not as severely as imagined by some. Domestic growth momentum in many emerging economies will attenuate the influence of U.S. weakness. And the accumulation of foreign currency reserves by these countries—the result of trade surpluses—provides an accessible resource to stimulate their own domestic growth to offset weaker exports, should that weakness materialize.

...[G]lobalization requires us to expand the amount of information we consider in our policy-making process. Second, our ability to accurately interpret price statistics affects our ability to communicate effectively with the public. Effective communication helps us anchor inflation expectations. Lapses in our ability to convey accurate and timely information about the underlying nature of price changes can create uncertainties about central bank objectives, damage our credibility, and impose costs on the economy. 

Will the U.S. slowing down really damp the price of oil, or the price of food, rice, or flour, cornmeal, the price of steel? … It’s not clear to me that a mild slowdown will put a dent in price pressures domestically. Obviously if you have a tail risk of a very severe global slowdown, then yes, I can see that. I don’t see that in the cards at least from my limited perspective. If you think in closed-economy terms, that’s more likely to obtain. If you think in global terms, it is less likely to obtain unless the whole world slows down.