Tim Duy and Paul Krugman both note the tale of two inflationary regimes. Slow growth and careful monetary policy in the industrialized countries is contributing to low core rates of inflation, while rapid growth and loose money in the developing world is contributing high rates of inflation and pressure on international commodity prices.

What lessons should we take and what should be done.

First, we should stop and not that this further bolsters the case that inflation is not just a monetary phenomenon but is actively controlled by monetary policy. I know that virtually all economists and most of my readers already believe that.

Nonetheless, there were arguments in the 90s that the worldwide decline in inflation suggested some general forces at work to which central bankers were only responding. It might have looked like Volker broke the back of inflation but it was really the international capital markets, rising global productivity or something like that. This event supports the hypothesis that the conduct of monetary policy can influence the rate of inflation.

Second, in a world without flexible exchange rates we have to think carefully about what monetary policy means and the inflation measures we look at. As long as other nations beg their currency to the dollar, those nation’s central bank will have some control over the dollar price of certain goods.

This is one of the reasons I believe we should strip out international commodity prices from the measure of inflation we are most concerned about. To some extent focusing on the traditional measure of core inflation – everything except food and energy – does this. This is different from traditional arguments about trying to target the “stickiest” prices. Those arguments still hold but there is another argument to be made for “controlling the controllables.” That is, focusing on the prices that are most strongly influenced by Fed policy.

Lastly, if developing nations insist on holding to their dollar policies we could be in for a rocky few years. In some ways the best case scenario is for them to let inflation roar to the point where their international competiveness is decreased and their trade balances return to a level consistent with fundamentals.

The alternative is to crush down on inflation at home while trying to maintain a cheap currency abroad. This is costly as it requires continuously buying holding larger and larger dollar reserves. There is a limit to each nations ability to do this and as the pegs pop there could be enormous international instability. However, unless there is something that I am missing, one day they must pop.

We have to be prepared for those moments.