Must-Read: A World Stumped by Stubbornly Low Inflation: “[The 1970s taught us that] allowing not just a temporary increase in inflation but a shift to above-target inflation expectations could be very costly…:
…At present we are… in a world that is the mirror image…. Market measures of inflation expectations have been collapsing and on the Fed’s preferred inflation measure are now in the range of 1-1.25 per cent over the next decade. Inflation expectations are even lower in Europe and Japan…. The Fed’s most recent forecasts call for interest rates to rise almost 2 per cent in the next two years, while the market foresees an increase of only about 0.5 per cent. Consensus forecasts are for US growth of only about 1.5 per cent for the six months from last October to March. And the Fed is forecasting a return to its 2 per cent inflation target on the basis of models that are not convincing to most outside observers….
In a world that is one major adverse shock away from a global recession, little if anything directed at spurring demand was agreed. Central bankers communicated a sense that there was relatively little left that they can do to strengthen growth or even to raise inflation. This message was reinforced by the highly negative market reaction to Japan’s move to negative interest rates. No significant announcements regarding non-monetary measures to stimulate growth or a return to target inflation were forthcoming, either…. Today’s risks of embedded low inflation tilting towards deflation and of secular stagnation… will require shifts in policy paradigms if they are to be resolved. In all likelihood the important elements will be a combination of fiscal expansion drawing on the opportunity created by super low rates and, in extremis, further experimentation with unconventional monetary policies.