Macro Weekly More inflation please
Group Economics
Nick Kounis +31 20 343 5616
2 October 2015 Eurozone inflation turned negative, while inflation is low in most big economies even outside of energy prices. The eurozone in particular could do with more inflation and QE is the only tool the ECB has. Higher inflation targets would give central backs more room to employ conventional monetary policy as it would allow them to slash real interest rates. Eurozone inflation back in the red
The downside of lowflation
This week was marked by figures showing that eurozone
The 2% targets have not provided central banks with enough
inflation turned negative again in September. Headline inflation
of a buffer on the downside against the background of various
fell to -0.1% yoy from +0.1% in August. That was mainly due to
shocks. In particular, it is real interest rates that matter for the
a hefty drop in energy prices. It would be difficult to complain
economy and the lower the level of inflation, the high the level
about that, given it means a windfall gain for consumers.
of real interest rates. This becomes a problem especially given
Having said that, inflation is too low outside of volatile food and
the limited room that central bankers generally see for taking
energy prices. Core inflation stood at just 0.9% yoy, basically
nominal rates below zero. The problem may have become
less than half the level the ECB targets over the medium term
more acute recently as lower trend growth means that neutral
for overall inflation.
interest rates are also lower.
Lowflation everywhere
Challenges for monetary policy
Low inflation is a world-wide phenomenon. Headline inflation in
Take the example of the eurozone. Trend growth may have
Japan also recently turned negative, with the ex-food measure
come down by around 1% over recent years, from just over 2%
that the BoJ targets at -0.1% yoy in August. Ex food and
in the years before the crisis to just over 1% currently. The
energy inflation firmed, but to a still low 0.8%. Inflation is also
neutral rate may also have come down by around the same
low even in economies further ahead in the cycle. In the US,
amount, from around 3.5% pre-crisis to around 2.5% now.
the core PCE deflator, targeted by the Fed to be 2%, stood at
Given the inflation goal of the ECB, that means the real neutral
1.3% in August. UK inflation was 0% in August, while the core
rate is now at just 0.5%. This means that to get conventional
was at 1%. Even in many emerging markets, inflation is
monetary policy stimulative, real interest rates need to become
relatively low. China's consumer price inflation stood at 2% yoy
deeply negative. However, that is not possible given current
in August, while producer prices were down by a breath-taking
low levels of inflation and an effectively zero nominal bound.
5.9% yoy. Indian CPI inflation was running at 3.7% yoy in
Some notable economists - including Larry Summers and
August, while wholesale prices were down by 5% yoy. Only in
Olivier Blanchard - have made the case for higher inflation
Brazil and Russia is inflation high among bigger economies,
targets over recent years because of this dilemma. For
partly reflecting a slump in their currencies.
instance, a 4% inflation target would given much more room for real rates to drop.
The death of inflation Central bankers spent the 1980s and part of the 1990s trying
For now QE is the only game in town
to slay inflation. Legendary Fed Chairman Paul Volker raised
Given where we are now, QE is the only option the ECB has to
interest rates sharply to push down inflation. More generally
ease monetary conditions and that comes with its own
central banks introduced implicit and eventually explicit
problems. A stepping up of asset purchases seems likely in the
inflation goals. Helped by the entry of China in to the global
coming months. To get inflation back up, it needs to generate
trade system as a low cost manufacturing powerhouse, these
domestic inflationary pressures to offset external disinflationary
efforts proved remarkably successful. It can be argued that
forces. This week data showed the unemployment rate stable
they were too successful. All the major central banks in
at 11% in September. Still unemployment remains on a
advanced economies have adopted inflation goals of 2%. This
downward trend, and wages seem to be firming. Still there is a
seemed a reasonable level in the past, but it can and should
long way to go to generate significant domestic inflationary
be questioned today.
forces in the eurozone. In the meantime, the risk is that the inflation expectations of households, companies and investors decline, making it even more difficult for the ECB to meet its