Is Inflation a Concern of the Past?

With regards to recent unexplained developments in inflation, one could think that inflation is “a concern of the past” as it might have lost its influence on economic development or is being balanced out by policy makers so well that it bears little relevance for economists’ anymore. This paper rejects this thesis as it shows that inflation has persistent, even increasing impact on economic development due to globalization, and that inflation is not being balanced well as sensitivity in inflation expectation is on the rise. Therefore, the lacking ability to explain inflation developments in the past years should encourage economists to improve their approaches instead of discharging the issue as “a concern of the past”.

Current deviations of economic reality from inflation theory challenge the relevance of inflation as an economic factor. Why is inflation of the recent decade so low if GDP growth increased, un­em­ploy­ment fell, and output gaps closed? Can the Philips curve still solve the “case of missing disinflation” [1] of Global Financial Crisis? And, can Friedman’s “Natural Rate of Unemployment” [2] be upheld in times of increasing unemployment-inflation independency?

We can only consent to the statement that “inflation is a concern of the past” (and hence discharge our responsibility as economists to tackle the before-mentioned questions) if either inflation doesn’t affect our economy anymore or the impact of inflation on market states is being balanced out by central banks and monetary policy makers insofar that it become neglectable. In the following, we argue that neither criteria are fulfilled and that we cannot regard inflation as a concern of the past.

Growing impact: Inflation is a sensitive trigger for important economic factors, such as GDP growth, un­em­ploy­ment rate, exchange rates, interest rates, etc. Beyond control of monetary policy makers, inflation has led to disastrous economic downturns (e.g., German Hyperinflation 1930s, Zimbabwe 2008, Venezuela 2018). Throughout the last 30 years, globalization[3] increasingly reflects on inflation as it reinforces the for­eign dimension in nearly all inflation-relevant factors (e.g., aggregate demand, pricing competition, raw mater­ials prices, wage bargain, interest rates, economic slack, inflation expectation, monetary policies, etc.). This increase in complexity makes it harder to estimate and to back-up balancing monetary policies scienti­fically – while inflation effects exert an even increased impact on growth, employment, and equality due to its enhanced international scope.

Rising inflation expectation sensitivity: If monetary policy makers were capable of steadily balancing out inflation to a communicated target, economists could regard inflation as constant and therefore greatly neglect it. This trust in monetary policy makers could be observed in an inflation expectation sensitivity of zero in the medium run. Despite improvements in the policy frameworks of developed countries, which increase central banks’ ability to balance out inflation, emerging countries are still very sensitive and even developed countries medium-run sensitivity rises (Beidas-Strom et al. 2016). Facing higher complexity and growing impact from globalization as well as the current lack of confidence in central banks, it seems unlikely that economists will trust monetary policy makers to balance out inflation sufficiently in the coming decades.

Answering the unsolved questions of inflation by simply declaring inflation as non-relevant either over­em­pha­sizes the monetary policy makers’ ability to balance inflation or underestimates the con­se­quen­ces of lacking monetary stability. The globalisation-based, increased complexity of inflation, its growing influence on core economic topics, and the volatile sensitivity in inflation expectations, require us to tackle both fallacies. We achieve this by continuing the path of empowering monetary policy makers with regards to central banks’ independency and transparency, as well as enhancing the current research on inflation models [4] in a globalized world to answer the unsolved questions.

[1] During the Global Financial Crisis in 2008/09 inflation decreased less than theory suggested (Williams 2010).

[2] The “Natural Rate of Unemployment” states that market imperfections, transaction costs, economic slack, and other im­pe­di­ments create a minimum level of unemployment that can only be undershot by rising inflation (Friedman 1968).

[3] Here defined as: increase of global trade flows, promotion of development of emerging markets, strengthening of international price competition, undermining bargaining power of workers (Foster 2018).

[4] See Foster 2018 for an overview.

LITERATURE:

• Williams, John C. (2010): “Sailing into Headwinds. The Uncertain Outlook for the U.S. Economy.” Presentation to a Joint Meeting of the San Francisco and Salt Lake City Branch Boards of Directors, Salt Lake City, Utah.
• Friedman, Milton (1968): “The Role of Monetary Policy.” Presidential address delivered at the 80th Annual Meeting of the American Economic Association. American Economic Review 58(1): 1–17.
• Beidas-Strom, Samya, et al. (2016): “Global Disinflation in an Era of Constrained Monetary Policy” in: International Monetary Fund, World Economic Outlook: 121–170.
• Foster, Kirstin J. (2018): “Has Globalization Changed the Inflation Process?”, forthcoming.

This OnePager is part of a six piece series written for the course "Advanced Economics: Economic Theory & Policy" at Hertie School of Governance, lectured by Prof Jean Pisani-Ferry, Chief Economist of the French President and Professor at Hertie School of Governance and SciencePo.