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7/2/2020 The end of inflation? - Inflation is losing its meaning as an economic indicator | Special report | The Economist

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The end of inflation?

Inflation is losing its meaning as an economic indicator

Economic policy must adapt, says Henry Curr

Oct 10th 2019 editionSpecial report

Oct 10th 2019

I nflation used to be the scourge of the world economy and the bane ofAmerican presidents. In 1971 amid an overheating economy Richard Nixon took to television to announce a freeze on “all prices and wages throughout the United

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States”. A board of bureaucrats ruled on what this meant for everything from golf club memberships to commodity futures. Gerald Ford, Nixon’s successor, preferred a grassroots approach. He distributed buttons bearing his slogan: win, for “whip in�ation now”. Ronald Reagan, running for o�ce four years later amid another

surge in prices, declared in�ation to be “as violent as a mugger, as frightening as an armed robber and as deadly as a hit man”.

Today the lethal assassin has gone missing. Most economies no longer struggle with runaway prices. Instead they �nd in�ation is too low, as judged by their in�ation targets. A decade of interest rates at or near rock-bottom has not changed that. Nor has the printing of money by central banks in America, the euro zone, Britain and Japan that has expanded their balance-sheets beyond a combined $15trn (35% of their combined gdp). Nor have unemployment rates that are in many countries the lowest they have been for decades.

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The imf counts among its members 41 countries in which monetary-policy targets in�ation. Add in the euro zone and America (where the Fed has multiple goals), and you get 43. Of those 28 will either undershoot their in�ation targets in 2019 or have in�ation in the bottom half of their target range, according to the fund’s most recent round of forecasts. (When those forecasts are updated on October 15th, after this special report goes to press, that number will probably rise.) By gdp 91% of the in�ation-targeting world is an in�ation laggard on this measure. That includes nearly all the advanced economies under examination Iceland is the sole

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nearly all the advanced economies under examination—Iceland is the sole exception—and more than half of the emerging markets.

This shift in the in�ation landscape re�ects both the successes and the failures of

economic policy. The advent of in�ation-targeting central banks since the 1990s has gradually immunised economies against runaway prices. But policymakers seem either unwilling or unable to stop in�ation falling short of their targets. This special report will argue that anchored in�ation expectations, technological change and the �ow of goods and capital across borders have conspired to make in�ation a less meaningful—and less malleable—economic indicator. Central banks are therefore �nding their targets harder to hit. At the same time, constraints on monetary policy mean that the risk of in�ation shortfalls looms larger than that of excessive price rises. Central bankers and politicians must �nd ways to adapt economic policy to this new world.

Disinflation nations Low in�ation is striking over both the long term and the short term. In the long term it is the culmination of a decades-long trend. The rich world conquered runaway prices by the late 1990s as governments made central banks independent and gave them in�ation targets. In the 2000s and the early 2010s commodity-price booms kept prices rising at a decent clip. But since the oil price crashed in 2014, in�ation above 2% has been rare. In emerging markets it is higher, but the direction of change is the same (see chart). For nearly two decades economists have talked of an era of “global disin�ation”.

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In the short term low in�ation is especially striking because it seems to defy the “Phillips curve”, the supposed inverse relationship between in�ation and unemployment. In two-thirds of countries in the oecd, a club of mostly rich countries, a record proportion of 15- to 64-year-olds have jobs. According to the models taught in economics courses and used by central banks, a jobs boom on this scale should have brought accelerating prices and wages. For the most part, it has not.

Central bankers have been caught out. For years they have promised that jobs growth would soon be over and in�ation would rise. They have repeatedly been proved wrong and are conscious of their mistakes. In February 2016 Mario Draghi, the outgoing head of the European Central Bank (ecb), described whether in�ation targets can be met as “the most fundamental question facing all major central banks”. Mark Carney, governor of the Bank of England, recently warned of an “increasingly untenable” economic-policy consensus. In March this year Jerome Powell, the Fed’s chairman, said low global in�ation was “one of the major challenges of our time”. The Fed’s failure to hit its in�ation target has encouraged an assault by President Donald Trump, who is incensed that in 2018 Mr Powell slowed growth by raising interest rates to see o� an in�ationary threat that has not yet materialised.

The disease of the 1970s and 1980s was simultaneous high in�ation and high unemployment. That both are now low might seem like cause for celebration. Certainly in�ation below target is a better problem to have than runaway prices. But it poses problems for three reasons. First, it represents a missed opportunity. Monetary policy could have been looser, and hence growth faster, without price pressures taking o�. Second, central banks missing their in�ation targets undermines their credibility. In Europe markets’ long-term in�ation expectations have sunk to little over 1%, lower than when the ecb started its quantitative-easing programme in early 2015, despite an in�ation target of below but close to 2%.

When in�ation targets are not credible, the future is more likely to spring a costly surprise. Unexpectedly low in�ation causes lenders to pro�t and borrowers to

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surprise. Unexpectedly low in�ation causes lenders to pro�t and borrowers to su�er, because debts do not shrink as fast in real terms as they were expected to when loans were agreed.

“ Central bankers have repeatedly been proved wrong Most important, low in�ation can be self-reinforcing. More signi�cant than the nominal interest rate set by central banks is the real interest rate, which adjusts for in�ation. As the public comes to expect lower in�ation, the real rate rises, weakening demand and pushing in�ation down even more. That would not be a problem if central banks could cut the nominal rate further to �ght the disin�ationary slump, but they have little room to do so. In Europe and Japan nominal interest rates are already below zero. They are near zero in Britain, and only a little higher in America. Though the exact location of the lower bound on interest rates is uncertain, it exists somewhere because the public always has the option of holding cash at a zero nominal return.

Why has in�ation reached this curious—and precarious—point? Some would argue that in�ation is falling short because governments have lost the ability to boost prices. This cannot be true. If it were, they could cut taxes to zero, boost spending, print money to �nance the resulting de�cits and never see an in�ationary downside. In�ation will always respond, eventually, to a determined policymaker who has access to interest rates and the printing presses. Governments can always debase their currencies, as high in�ation in Argentina and Turkey shows.

This might suggest that below-target in�ation re�ects only a failure of ambition. But that is not right either. In�ation has become harder to �ne-tune because economies have changed in ways that are not yet fully understood. Monetary policy must not just become more ambitious but also adapt to rely less on failing models and to take a longer-term view. And while central banks are hamstrung by low rates, �ghting low in�ation will increasingly fall to �scal policy. The case for reform rests �rst on an understanding of where economic models have gone wrong. 7

See next article: Economists’ models of in�ation are letting them down

7/2/2020 The end of inflation? - Inflation is losing its meaning as an economic indicator | Special report | The Economist

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The world economy The end of inflation?

→ Inflation is losing its meaning as an economic indicator

→ Economists’ models of inflation are letting them down

→ Technology is making inflation statistics an unreliable guide to the economy

→ Low inflation is a global phenomenon with global causes

→ Why onions and pigs can give economists a headache

→ Most, but not all, emerging markets have overcome high inflation

→ How to make economic policy fit for a world of low inflation

→ Sources and acknowledgments

This article appeared in the Special report section of the print edition under the headline "The end of in�ation?"

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7/2/2020 The end of inflation? - Inflation is losing its meaning as an economic indicator | Special report | The Economist

https://www.economist.com/special-report/2019/10/10/inflation-is-losing-its-meaning-as-an-economic-indicator 7/8

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7/2/2020 The end of inflation? - Inflation is losing its meaning as an economic indicator | Special report | The Economist

https://www.economist.com/special-report/2019/10/10/inflation-is-losing-its-meaning-as-an-economic-indicator 8/8