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Globalization has profoundly affected politics, society and economic performance. Among its most significant results has been persistent downward pressure on prices. As governments across the world consider their participation in free trade, they should appreciate that withdrawal could come at a high cost.

Among the most prominent developments of the last generation has been the taming of inflation in major markets. Monetary policy has often been credited for this; restrictions in money growth and the anchoring of expectations have been widely cited as bringing about this end. But the dominant driver of this outcome may instead have been the integration of national markets into a global marketplace.

A direct and easily measured example comes from trade in goods. Price movements for goods in an exporting nation are echoed in price movements of finished and intermediate goods in an importing nation. This is especially true for globally traded raw materials, where individual countries are often price takers. The chart below shows the growth in the trade of both final and intermediate products, where the blue line represents total trade in finished goods (exports plus imports as a percentage of GDP) and the red line charts the growth of trade in intermediate goods.

Indirect effects of globalization on prices can be even more powerful. The import content of U.S. personal consumption expenditures is less than 15 percent, but the influence of trade on the prices paid is much larger. Opening an economy to trade leads to competition at a global level and pushes down prices of domestically produced goods. The “threat” of cheaper imported substitutes keeps a lid on domestic production costs. Like the cost any other factor of production, wage growth (and its impact on overall inflation) is also kept in check through this mechanism.

It works something like this: slack in the Chinese economy keeps Chinese wages, and export prices, down — a phenomenon often called “exporting deflation.” Since U.S. producers compete in the same marketplace, they must either gain efficiencies or increase the import content of their value chains to remain competitive.

A recent paper by the Bank for International Settlements (BIS) documents the importance of global value chains in determining domestic prices. Their findings challenge the country-centric view of inflation and emphasize the need to look at the global output gap (actual output minus potential output) as a determinant of domestic inflation.

To illustrate this, the charts below plot U.S. inflation against the U.S. output gap (left) and against the global output gap (right). Each dot represents a year from the period 1985-2015. An upward sloping scatter would suggest strong positive correlation between the two variables. As we can see, the U.S. slack versus inflation scatter is quite dispersed, while the association with global slack is tighter and more positive.

To be sure, this is an asymmetric relationship, driven by both the direction of trade and the type of goods traded. Developing nations have a much larger impact on developed ones than the other way around, as the former have a competitive advantage in the production of goods.

The Federal Reserve was among the first to appreciate this. In the 1990s, Alan Greenspan cited a “new paradigm” as support for holding interest rates constant even as real growth accelerated. A later paper assessing import competition’s impact on U.S. inflation vindicated his observation. As a result of Greenspan’s prescience, the American economy entered what came to be known as the Great Moderation —an era of unprecedented price and output stability that lasted until 2008.