In the United States, Europe, Japan, and other
developed economies, the recent growth acceleration has been driven by
an increase in aggregate demand, a result of continued expansionary monetary
and fiscal policies, as well as higher business and consumer confidence.
That confidence has been driven by a decline in
financial and economic risk, together with the
containment of geopolitical risks, which, as a result, have so far
had little impact on economies and markets.
Because stronger demand means less slack in
product and labor markets, the recent growth acceleration in the advanced
economies would be expected to bring with it a pickup
in inflation. Yet core inflation has fallen in the US this year and
remains stubbornly low in Europe and Japan. This creates a dilemma for major
central banks – beginning with the US Federal Reserve and the European
Central Bank – attempting to phase out unconventional monetary policies:
they have secured higher growth, but are still not
hitting their target of a 2% annual inflation rate.
One possible explanation for the mysterious
combination of stronger growth and low inflation is that, in addition to
stronger aggregate demand, developed economies have been experiencing
positive supply shocks.
Such shocks may come in many forms.
Globalization keeps cheap
goods and services flowing from China and other emerging markets.
Weaker unions and workers’ reduced bargaining power
have flattened out the Phillips curve(インフレーションと失業の関係を示したもの), with
low structural unemployment producing little wage
inflation. Oil and commodity prices are low
or declining. And technological innovations,
starting with a new Internet revolution, are reducing the costs of goods and
Standard economic theory suggests that the
correct monetary-policy response to such positive supply shocks depends on
their persistence. If a shock is temporary, central banks should not react
to it; they should normalize monetary policy, because eventually the shock
will wear off naturally and, with tighter product and labor markets,
inflation will rise. If, however, the shock is
permanent, central banks should ease monetary conditions; otherwise, they
will never be able to reach their inflation target.
This is not news to central banks. The Fed has
justified its decision to start
normalizing rates, despite below-target core inflation, by arguing that
the inflation-weakening supply-side shocks are temporary. Likewise, the ECB
is preparing to taper its bond purchases in 2018, under the assumption that
inflation will rise in due course.
If policymakers are incorrect in assuming that
the positive supply shocks holding down inflation are temporary, policy
normalization may be the wrong approach, and unconventional policies should
be sustained for longer. But it may also mean the opposite:
if the shocks are permanent or more persistent than expected, normalization
must be pursued even more quickly, because we have already reached
a “new normal” for inflation.
This is the view taken by the Bank for
International Settlements, which argues that it is
time to lower the inflation target from 2% to 0% – the rate that can
now be expected, given permanent supply shocks. Trying to achieve 2%
inflation in a context of such shocks, the BIS warns, would lead to
excessively easy monetary policies, which would put upward pressure on
prices of risk assets, and, ultimately, inflate dangerous bubbles. According
to this logic, central banks should
normalize policy sooner, and at a faster pace, to prevent another
central banks don’t agree with the BIS. They believe that, should
asset-price inflation emerge, it can be contained with macroprudential
credit policies, rather than monetary policy.
Of course, advanced-country central banks hope
such asset inflation won’t appear at all, because inflation is being
suppressed by temporary supply shocks, and thus will increase as soon as
product and labor markets tighten. But, faced with the possibility that
today’s low inflation may be caused by permanent supply shocks, they are
also unwilling to ease more now.
So, even though central banks
aren’t willing to give up on their formal 2% inflation
target, they are willing to prolong the timeline for achieving it, as
they have already done time and again, effectively conceding that inflation
may stay low for longer. Otherwise, they would need to sustain for much
longer their unconventional monetary policies, including quantitative easing
and negative policy rates – an approach with which most central banks (with
the possible exception of the Bank of Japan) are not comfortable.
This central bank patience risks de-anchoring
inflation expectations downward. But continuing for much longer with
unconventional monetary policies also carries the risk of undesirable
asset-price inflation, excessive credit growth, and bubbles. As long as
uncertainty over the causes of low inflation remains, central banks will
have to balance these competing risks.