The inflation that didn’t bark

All the dire warnings about inflation have turned out to be wrong, and deflationary fear-mongering is also lacking conviction.

The biggest story in the global economy this year is the lack of inflation.
The latest data from the OECD shows that inflation among its members has fallen to 1.3 per cent, and it looks like the broader IMF measure of global inflation has fallen below 3 per cent. The first and only time this has happened before was in the Great Recession of 2008-9.
Yesterday the Reserve Bank of Australia maintained its easing bias, observing happily that “inflation has … moderated over recent months”. According to the unofficial inflation gauge from TD Securities and the Melbourne Institute on Monday, Australian underlying inflation is down to 1.9 per cent – beneath the Reserve Bank’s target band.
So all those dire warnings that the epic money printing going on the US and more recently Japan would lead to an inflationary breakout have turned out to be completely wrong. Far from rising, inflation is falling.
The fear-mongers have had to switch to warning about deflation, but with bond yields rising – moderately, not spiking - this lacks conviction. Although deflationary forces are at work in Europe, global growth has stabilised after two years of slowing down, and is now picking up.
And while it’s true that central banks would prefer inflation of 2 per cent, they are no doubt feeling pretty comfortable now after a couple of scares in the past few years when prices increased at the same time as growth slowed; in 2013 the opposite has occurred.
What’s causing this? There is still a huge overhang in the global labour market suppressing wages, credit multipliers remain broken after the credit crisis, banks are still wary and the fracking revolution in the United States is cutting energy prices there. These factors have now been joined by weak demand in China and Europe suppressing commodity prices.
Note, by the way, that the Federal Reserve’s stated unemployment target is 6.5 per cent, which is not very ambitious and hardly represents full employment. In fact the Fed is targeting a continuing pool of unemployed to keep wages and inflation down.
Is there a risk of a deflationary spiral? Perhaps. It arises mainly from governments working against the efforts of central banks by imposing austerity, especially in Europe and to some extent in the US, with the so-called sequester spending cuts. There is even mild austerity going on in Australia as both parties deal with a structural deficit caused by ten years of over-spending.
But the most likely scenario is a gradual increase in inflation as confidence continues to improve and unemployment gradually falls around the world. Against that, commodity and energy prices could remain weak because of depression in Europe and slower growth in China, not to mention cheap gas in America.
Falling inflation has been a key factor in the bull market in shares over the past 12 months. Low consumer prices remove earnings distortions and justify higher price/earnings multiples and higher asset prices.
Low inflation is also underpinning the ‘currency wars’. For the first time in decades, central banks, including Australia’s, feel comfortable targeting a lower exchange rate because they have some room to move on inflation.
Recessions are almost always caused by inflation – the Great Recession was also the Great Exception. Without inflation, there won’t be another recession until bankers forget the lessons of 2008 and go crazy again.



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