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Taking the Air Out of All the Fears Over Inflation

Taking the Air Out of All the Fears Over Inflation

Tuesday, 19 December 2017 09:23 AM Current | Bio | Archive

There were moments in 2017 when it seemed that whenever there was a lack of things to report upon, commentators would dust of the “Why is inflation so low?” story.

But is inflation really unusual?

The reality is that inflation is not especially low in and of itself. In the U.S. and Europe, inflation measures are hovering around their long-term averages. Some measures a quarter point below, some above.

It is true that inflation is generally below central bank targets, not in all countries, but not unusually below central bank targets. What is unusual perhaps, is that inflation has remained relatively subdued while labor markets, especially in the United States have tightened.

The conundrum is not that inflation is unusually low, it’s that there were expectations that it being higher than it has turned out to be.

The fevered search for explanations has thrown up some obvious falsehoods.

Low inflation is not a globalization story. That’s relatively quickly proved. If globalization were powering inflation, then the core consumer price inflation rates would be correlated across countries as inflation would have to have a common cause. Core consumer price inflation rates are not in fact strongly correlated across countries.

The price of imports is also generally poorly correlated to the retail price of the same goods in many economies, including the United States.

Technology is also cited as a factor driving prices lower. Technology can have a relative price effect. Sectors that become more efficient as a result of changes in technology are given increased pricing power versus specific sectors that are not specifically exposed to technology.

It is also possible that changes in technology are increasing pricing power in certain areas of the economy.

It’s possible to discriminate on pricing in some instances. The price that one person pays may be very different from the price that another person pays.

So, what is happening?

There are two related explanations.

The first is that the importance of government-controlled, calculated or statistically adjusted prices has been increasing in recent years. This means that although market forces may support inflation, inflation can still be lowered.

However, these non-market forces are not guaranteed to drive inflation lower forever, they may indeed drive inflation higher as for example have done in Sweden this year.

The second factor is that central banks have done what they were asked to.

Ever since the Volcker-shock, central banks have been tasked with bringing inflation down to a low and stable level and this, the central banks have generally done.

Quite anyone is surprised by the outcome is a bit of a mystery, but having reigned in the market based forces of inflation, relatively little importance is then given to non-market forces of inflation.

Inflation in the world economy in 2018 may be a faction higher than it was in 2017, at least over the course of the year. An because of non-market prices, there may be a balance of risks that markets would be surprised to the upside by inflation.

However, we are unlikely to face an inflation crisis as long as central banks remain independent and guided by economists.     

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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The conundrum is not that inflation is unusually low, it’s that there were expectations that it being higher than it has turned out to be.
inflation, economy, investor, fears
Tuesday, 19 December 2017 09:23 AM
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