El-Erian Warns Vexed Central Bankers “The Lowflation Demon Is Real”

Wednesday, August 23, 2017
By Paul Martin

by Mohamed El-Erian via Bloomberg.com,
Aug 23, 2017

Persistently low inflation, or “lowflation,” is vexing lots of people. According to the recent minutes of policy meetings of the Federal Reserve and the European Central Bank, central banks on both sides of the Atlantic have been trying to identify the causes — but with limited success so far. This complicates monetary policy decisions and undermines the range of institutional solutions that have been proposed by academics. Until this changes, central banks may need to think more holistically about the objectives of monetary policy, including the unintended consequences for future financial stability and growth of being too loose for too long.

Four facts stand out in reviewing recent inflation data:

Inflation rates have been unusually and persistently low.
This is primarily an advanced-country phenomenon.
Inflation has not responded to the prolonged pursuit of ultra-low interest rates and huge injections of liquidity by central banks through quantitative easing.
This has coincided with a period of notable job creation, especially in the U.S., thereby flattening the “Phillips curve” that plots unemployment and inflation rates.

Many economists worry that such lowflation frustrates the relative price adjustments that are critical to a well-functioning market economy. And if the inflation rate, and related inflationary expectations, flirt with the zero line for too long (as had occurred in Europe), there is an increased risk of actual price declines that encourages consumers to postpone their purchases, weakens economic growth, and undermines policy effectiveness (as had been the case in Japan).

The many reasons that have been put forward for the lowflation phenomenon range from benign measurement errors to worrisome structural drivers, with a host of “idiosyncratic factors” in the middle. Indeed, the Fed minutes released last week contain a list of possible drivers. These also note that a few central bankers are questioning the usefulness of traditional models and approaches in explaining and predicting inflation behavior. The recent ECB minutes also refer to “a number of explanatory factors” for lowflation and the importance of monitoring “the extent to which such factors could be transient or more permanent.” (And that is not the only issue vexing central bankers and economists more generally — productivity and wage formation have also been puzzles to an unusual extent.)

The Rest…HERE

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