In­fla­tion, the Fed, and the Big Pic­ture

Financial Mirror (Cyprus) - - FRONT PAGE -

In­fla­tion – its causes and its con­nec­tion to mon­e­tary pol­icy and fi­nan­cial crises – was the theme of this year’s in­ter­na­tional con­fer­ence of cen­tral bankers and aca­demics in Jack­son Hole, Wy­oming. But, while pol­i­cy­mak­ers’ de­sire to be pre­pared for po­ten­tial fu­ture risks to price sta­bil­ity is un­der­stand­able, they did not place these con­cerns in the con­text of re­cent in­fla­tion de­vel­op­ments at the global level – or within his­tor­i­cal per­spec­tive.

For the 189 coun­tries for which data are avail­able, me­dian in­fla­tion for 2015 is run­ning just be­low 2%, slightly lower than in 2014 and, in most cases, be­low the In­ter­na­tional Mon­e­tary Fund’s pro­jec­tions in its April World Eco­nomic Out­look. As the fig­ure shows, in­fla­tion in nearly half of all coun­tries (ad­vanced and emerg­ing, large and small) is now at or be­low 2% (which is how most cen­tral bankers de­fine price sta­bil­ity).

Most of the other half are not do­ing badly, ei­ther. In the pe­riod fol­low­ing the oil shocks of the 1970s un­til the early 1980s, al­most two-thirds of the coun­tries recorded in­fla­tion rates above 10%. Ac­cord­ing to the latest data, which runs through July or Au­gust for most coun­tries, there are “only” 14 cases of high in­fla­tion (the red line in the fig­ure). Venezuela (which has not pub­lished of­fi­cial in­fla­tion sta­tis­tics this year) and Ar­gentina (which has not re­leased re­li­able in­fla­tion data for sev­eral years) fig­ure promi­nently in this group. Iran, Rus­sia, Syria, Ukraine, and a hand­ful of African coun­tries com­prise the rest.

The share of coun­tries record­ing out­right de­fla­tion in con­sumer prices (the green line) is higher in 2015 than that of coun­tries ex­pe­ri­enc­ing dou­ble-digit in­fla­tion (7% of the to­tal). What­ever nasty sur­prises may lurk in the fu­ture, the global in­fla­tion en­vi­ron­ment is the tamest since the early 1960s.

In­deed, the risk for the world econ­omy is ac­tu­ally tilted to­ward de­fla­tion for the 23 ad­vanced economies in the sam­ple, even eight years af­ter the on­set of the global fi­nan­cial cri­sis. For this group, the me­dian in­fla­tion rate is 0.2% – the low­est since 1933. The only ad­vanced econ­omy with an in­fla­tion rate above 2% is Ice­land (where the latest 12-month read­ing is 2.2%).

While we do not know what might have hap­pened were poli­cies dif­fer­ent, one can easily imag­ine that, ab­sent quan­ti­ta­tive eas­ing in the United States, Europe, and Ja­pan, those economies would have been mired in a de­fla­tion­ary post-cri­sis land­scape akin to that of the 1930s. Early in that ter­ri­ble decade, de­fla­tion be­came a re­al­ity for nearly all coun­tries and for all of the ad­vanced economies. In the last two years, at least six of the ad­vanced economies – and as many as eight – have been cop­ing with de­fla­tion.

Fall­ing prices mean a rise in the real value of ex­ist­ing debts and an in­crease in the debt-ser­vice bur­den, ow­ing to higher real in­ter­est rates. As a re­sult, de­faults, bank­rupt­cies, and eco­nomic de­cline be­come more likely, putting fur­ther down­ward pres­sures on prices.

Irv­ing Fisher’s pre­scient warn­ing in 1933 about such a debt-de­fla­tion spi­ral res­onates strongly to­day, given that public and pri­vate debt lev­els are at or near his­toric highs in many coun­tries. Es­pe­cially in­struc­tive is the 2.2% price de­cline in Greece for the 12 months end­ing in July – the most se­vere ex­am­ple of on­go­ing de­fla­tion in the ad­vanced coun­tries and coun­ter­pro­duc­tive to an or­derly so­lu­tion to the coun­try’s prob­lems.

Me­dian in­fla­tion rates for emerg­ing-mar­ket and de­vel­op­ing economies, which were in dou­ble dig­its through the mid-1990s, are now around 2.5% and fall­ing. The sharp declines in oil and com­mod­ity prices dur­ing the latest su­per­cy­cle have helped mit­i­gate in­fla­tion­ary pres­sures, while the gen­er­alised slow­down in eco­nomic ac­tiv­ity in the emerg­ing world may have con­trib­uted as well. But it is too early to con­clude that in­fla­tion is a prob­lem of the past, be­cause other ex­ter­nal fac­tors are work­ing in the op­po­site di­rec­tion. As Ro­drigo Ver­gara, Gover­nor of the Cen­tral Bank of Chile, ob­served in his pre­pared re­marks at Jack­son Hole, large cur­rency de­pre­ci­a­tions in many emerg­ing mar­kets (most no­tably some oil and com­mod­ity pro­duc­ers) since the spring of 2013 have been as­so­ci­ated with a rise in in­fla­tion­ary pres­sures in the face of wider out­put gaps.

The anal­y­sis pre­sented by Gita Gopinath, which es­tab­lishes a con­nec­tion be­tween the price pass-through to prices from ex­change-rate changes and the cur­rency in which trade is in­voiced, speaks plainly to this is­sue. Given that most emerg­ing-mar­ket coun­tries’ trade is con­ducted in dol­lars, cur­rency de­pre­ci­a­tion should push up im­port prices al­most one for one.

At the end of the day, the US Fed­eral Re­serve will base its in­ter­est-rate de­ci­sions pri­mar­ily on do­mes­tic con­sid­er­a­tions. While there is more than the usual de­gree of un­cer­tainty re­gard­ing the mag­ni­tude of Amer­ica’s out­put gap since the fi­nan­cial cri­sis, there is com­par­a­tively less am­bi­gu­ity now that do­mes­tic in­fla­tion is sub­dued. The rest of the world shares that be­nign in­fla­tion en­vi­ron­ment.

As the Fed pre­pares for its Septem­ber meet­ing, its pol­i­cy­mak­ers would do well not to ig­nore what was over­looked in Jack­son Hole: the need to place do­mes­tic trends in global and his­tor­i­cal con­text. For now, such a per­spec­tive favours pol­icy grad­u­al­ism.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.