Fraser Forum

Inflation ‘improves’ by going up?

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It’s strange how economists’ way of talking about inflation has changed over the last couple of decades. Inflation used to be unambiguously bad. In the 1970s and 1980s the “misery index” added the inflation and unemployment rates together and told you how badly your economy was performing. Implicitly, a percentage point of inflation counted as badly as a percentage point of unemployment.

Not so much anymore, it seems. I was reading the latest issue of TD Economics’ excellent weekly newsletter “Dollars and Sense” and found myself puzzling over how it characterized prospective changes in inflation. At one stage its authors talk about inflation being “likely to improve.” But it’s not entirely clear whether they mean accelerate or decelerate. Time was “improvement” would have meant “go away.” Now it’s not so clear.

The context is that since 2008 there have been oceans of monetary stimulus by central banks the world round, with the result that interest rates have been abnormally low for almost a full decade now. But, surprisingly, even though most of the big economies are recovering—maybe even have recovered in the sense that their unemployment rates are near customary cyclical lows—inflation is still quiescent. In the United States, despite an impressively low 4.4 per cent unemployment rate, inflation is still below the Fed’s two per cent target (at 1.6 per cent per year in June). In Canada in June it was only 1.0 per cent, though our unemployment rate is still 6.5 per cent, not far above levels where most economists think inflation will begin to pick up steam.

The context for all this is central banks trying to decide when to pull the interest-rate trigger in the face of good numbers for output and employment growth which you’d think is bound to mean (soon? eventually? some day?) higher inflation numbers. But inflation doesn’t seem to be picking up as much as, according to past performance, it should. In fact the TD Economics authors refer to it as being “serially disappointing” over the current economic cycle.

There was a time when disappointing inflation would have been inflation that kept rising. In this case, it’s inflation that comes in below expectations. Ordinarily, if something bad occurs less than expected, you would think that was a good thing. But here, what seems to disappoint is not so much the harmful event itself as the unfulfilled expectation of it. “We thought the plague was coming but it didn’t. How disappointing!”  

Why is inflation so low these days despite the pretty respectable pick-up in growth? TD Economics credits (or blames!) China, extraction efficiencies in oil and gas, and the “game-changing impact of online retailing,” though you might think these supply effects would cause one-time reductions in the price level, rather than a drop in its rate of change. Also, for some countries, those whose currencies have risen against the U.S. dollar, there’s “flow-through deflation” as imports become cheaper—though the opposite will happen in the country whose currency is falling, the U.S.

If today’s world really is less inflation-prone than it has been, you might think countries would respond by adjusting their inflation targets downward. If we’re back to what are historically acceptable (even good) rates of unemployment and the inflation rate is only one per cent, why insist on holding to a 1990s target of two per cent, which will require even more prolonged monetary stimulus? Why not just bank the reduction in inflation and welcome a world in which the price level takes two generations to double, not one?

Language evolves, we know, but sometimes you wish it wouldn’t.


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