Macro weekly 2 october 2015

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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


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Macro weekly 2 october 2015 by ABN AMRO - Issuu