Abstract
In this chapter we look at global inflation trends over the last decade and try to disentangle factors that could explain the ultra-low levels of inflation during the recovery from the Great Recession. We review the literature on the subject, which points at possible structural shifts in price and wage setting processes in recent decades, such as changes in inflation’s cyclical sensitivity to economic slack, in the role being played by forward-looking and backward-looking inflation expectations, or in the relevance of global factors. We then test empirically whether changes in the coefficients of the Phillips curve in the wake of the global financial crisis can explain the behaviour of inflation over this period for a large group of advanced economies. Our results show a wide range of variation between countries, and in some cases the findings are insufficiently robust to offer a satisfactory explanation of the recent course of inflation. Nevertheless, the persistence of inflation and the increased importance of backward-looking inflation expectations in some countries may pose risks for inflation-expectation anchoring and central bank credibility. Finally, we review the adverse effects on the real economy of ultra-low inflation over an extended period and analyse the policy options for addressing this problem.
This chapter is an updated version of the paper that was published under the same title in the Banco de España Occasional Working Paper Series.The authors would like to thank Marina Conesa, Roberto Pascual and Patricia Sánchez for their excellent research assistance. All the views are those of the authors and do not necessarily reflect the views of the Banco de España.
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Notes
- 1.
For a more comprehensive list of references see Berganza et al. (2016), “Determinants and implications of low global inflation rates”, Banco de España Occasional Working Paper Series No. 1608.
- 2.
The global inflation rate has been constructed from a sample of 27 countries, representing 80% of global GDP.
- 3.
Changes in indirect taxes and administered prices have also made a big contribution to changes in inflation in other regions, with an impact on their apparently limited response to cyclical changes in the economy. In a number of euro area countries, for example, fiscal systems were reformed before the crisis to give indirect taxes a more central role, and if the impact of these tax increases is removed then inflation is seen to respond more strongly to the economic slowdown.
- 4.
Under this framework (see the formula below) inflation (\( \pi_{t} \)) would be determined by inflation expectations—possibly a combination of forward looking (\( LT_{t} \)) and backward looking elements (\( \pi_{t}^{{\prime }} \))—and by the degree of cyclical slack in the economy (\( slack_{t} \)):
$$ \pi_{t} = \lambda LT_{t} + \left( {1 - \lambda } \right)\pi_{t}^{{\prime }} + \beta_{1} slack_{t} +\upvarepsilon_{t}. $$ - 5.
See, for example, Stella and Stock (2013) for the case of the United States.
- 6.
A number of authors point to the deflationary effect of population ageing, particularly in the case of Japan, due primarily to the negative effect on economic growth and natural interest rates (Shirakawa 2012). For a more general discussion of the effects of ageing, see, for example, Nickel et al. (2017). These authors point to the greater preference of longer-lived generations for low inflation, as their income is mainly fixed, and their lower sensitivity to monetary policy. By contrast, Juselius and Takáts (2015) find a positive correlation between the ratio of dependent population (young and elderly people) and a high inflation rate.
- 7.
- 8.
See, for example, Campa and Goldberg (2008), or BIS (2014). Gopinath (2015) highlights, in the US case, the predominance of dollar-denominated imports as being a key factor in the reduced pass-through of the exchange rate into inflation. Factors such as exporters’ pricing to market makes the extent of pass-through of exchange rate movements into import prices incomplete (see, for example, Bank of England 2015).
- 9.
For a contrasting opinion, see Hara et al. (2015) for the case of Japan since the 2000s. Moreover, Forbes (2015) and Forbes et al. (2015) also find that pass-through in the United Kingdom increased in the wake of the crisis. Furthermore, they highlight that to explain how this pass-through has evolved it is essential to distinguish the origin of the change in the exchange rate (i.e. whether it is due to domestic demand, global demand, domestic monetary policy, global supply shocks, domestic productivity, etc.). The largest degree of pass-through is found if the rise in the exchange rate is due to supply-side shocks, particularly domestic ones, while rising exchange rates linked to global or domestic demand shocks can cause price rises. Forbes et al. (2017) extend this analysis to a broad group of advanced and emerging market economies and Comunale and Kunovac (2017) apply the same methodology to the euro area.
- 10.
This situation is very different from that in the second half of the 1990 s, when there was a tendency to predict higher inflation than actually occurred in the advanced economies. Then, however, the technology revolution boosted productivity and potential growth, allowing greater slack and reducing inflationary pressures.
- 11.
For a detailed analysis of recent trends in the US labour market, see Berganza (2014). Some authors have suggested that the long-term unemployed disconnect from the labour market and do not exert the same pressure on wages as the short-term unemployed (Ball and Mazumder 2015). For a contrary view, see Kiley (2014).
- 12.
Ball and Mazumder (2011) find that according to traditional estimates of the Phillips curve core inflation in the US should have declined well below zero during the crisis (even reaching less than −3%, although it actually just fell to 0.6%). This contrasts with the historical evidence that pronounced and persistent negative output gaps tend to lead to significant deflation in terms of both prices and wages.
- 13.
- 14.
For some authors, the Phillips curve presents non-linearities, being flatter when unemployment rates are higher, due to downward wage rigidities, and steeper when unemployment rates are very low (Linder et al. 2012 or Semmler and Gross 2017). For a contrasting view, see Musso et al. (2009) and for the case of the Spanish economy Álvarez et al. (2015) also find evidence that inflation responds differently in booms than in recessions, being higher in the contractionary phases of the cycle.
- 15.
As indicated, for example, by Stock and Watson (2010).
- 16.
- 17.
- 18.
For an analysis applied to the Spanish case, see Izquierdo and Puente (2015).
- 19.
There is extensive evidence of these downward rigidities in nominal wages, even in the US case (see, for example, Linder et al. 2012).
- 20.
- 21.
- 22.
- 23.
Bentolila et al. (2007) highlight the importance of immigration in flattening the Phillips curve in Spain between 1995 and 2006.
- 24.
- 25.
- 26.
Many authors, while not denying that global factors have a bigger influence, have questioned the centrality of global effects in explaining the recent episode of low inflation and the one prior to the global financial crisis. They also question the supposed inability of monetary authorities to control inflation for this reason. See, for example, Rogoff (2006), Ball (2006), Yellen (2006), Bernanke (2007), Woodford (2010), Carney (2015) or Mikolajun and Lodge (2016).
- 27.
- 28.
- 29.
See, for example, ECB (2015) or Yellen (2015). Ciccarelli and García (2015) find significant spillover effects since August 2014 from long-term inflation in the euro area on expectations in other regions, particularly the United States. This could explain the way market expectations were seen to drop at the same time.
- 30.
- 31.
See, for example, BIS (2015), IMF (2016) or Ciccarelli and Osbat (2017). Nevertheless, the limitations of measures of inflation expectations derived from financial instruments (such as the existence of liquidity premiums) must be borne in mind, while, by contrast, expectations reported in surveys have remained much more stable (Yellen 2015). However, Lyziak and Paloviita (2016) find that in the euro area longer-term inflation expectations of professional forecasters and consumers have become somewhat more sensitive to shorter-term forecasts and to actual HICP inflation in the post-crisis period, which suggests that inflation expectations in the euro area have shown some signs of de-anchoring.
- 32.
- 33.
The recent “Comprehensive Assessment” of the Quantitative and Qualitative Easing strategy by the Bank of Japan points to the adaptive character of inflation expectations as one of the main determinants of persistently very low inflation in Japan (Bank of Japan 2016). Locarno et al. (2017) point to the possibility of similar risks of deanchoring expectations for the euro area.
- 34.
- 35.
Australia, Austria, Belgium, Canada, Denmark, the euro area, Finland, France, Germany, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, South Korea, Spain, Sweden, Switzerland, the United Kingdom, and the United States.
- 36.
The sum of the coefficients of forward- and backward-looking inflation expectations is restricted to 1 in order to guarantee that the Phillips curve is vertical in the long run.
- 37.
Another variable typically used in the literature to capture global factors affecting inflation is the global output gap. We tried this variable (the OECD output gap) in our regressions, but it showed a high correlation with domestic output gaps and its coefficient was not significant.
- 38.
Estimation methods vary depending on the empirical approach and the definition of variables. Some authors (e.g., Blanchard et al. 2015) estimate jointly the evolution of inflation and the NAIRU (or potential output) obtaining time varying coefficients by applying the Kalman filter. Other studies, along the new Keynesian spirit, use the inflation rate in period t + 1 as the forward-looking component of inflation expectations and estimate by GMM, but this approach is subject to critiques due to the weakness of instruments. In line with studies such as Ball and Mazumder (2011) or Banco de España (2015), we use long-term inflation forecasts from Consensus or the central bank target which allow estimation by OLS for each country. Panel data settings are not considered due to the specific behaviour of inflation in each country.
- 39.
First quarter of 1999 for the euro area.
- 40.
In Berganza, del Río and Borrallo (2016) the breakdown of inflation for the rest of countries is shown.
- 41.
Svensson estimates that with inflation 0.6 pp below target between 1997 and 2011 the unemployment rate was raised by 0.8 pp.
- 42.
- 43.
However, for some authors, mainly those associated with the BIS, the historical evidence shows that not all deflationary episodes are harmful, particularly in the case of those that result from positive supply shocks. See, for example, BIS (2015), Borio et al. (2015). Arias et al. (2015), for their part, indicate that the harmful effects of low inflation crucially derive from its origin, and the ability of monetary policy to respond. The effects are more positive if deflation is due to positive supply shocks and monetary policy is not limited by the effective lower bound.
- 44.
The same thing could happen when trying to control inflation when it starts to rise.
- 45.
Reifschneider and Williams (2000) found that with a 2% inflation target monetary policy would be constrained by the effective lower bound only 5% of the time and that these episodes would have an average duration of a year.
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Appendix: Definitions and Sources of Variables
Appendix: Definitions and Sources of Variables
Variable | Definition | Sources |
|---|---|---|
Core CPI | Annualized quarterly core inflation rate | Bureau of Economic Analysis (USA), European Central Bank (Euro Area), Ministry of Economics (Japan), OECD Economic Outlook (Canada, Germany, France, Italy, Denmark, Switzerland, Norway, Sweden, Spain, Finland, Austria, Netherlands, Belgium, Australia, Korea, United Kingdom, Portugal, Ireland, New Zealand), Datastream |
Unemployment gap | The difference between the quarterly unemployment rate and the NAIRU | FRED (USA-unemployment rate), CBO (USA-NAIRU), Bank of Japan (Japan), OECD (Canada, Germany, France Italy, Denmark, Switzerland, Norway, Sweden, Spain, Finland, Austria, Netherlands, Belgium, Australia, Korea, Euro Area, United Kingdom, Portugal, Ireland, New Zealand-NAIRU), national statistics institutes (Canada, Germany, France Italy, Denmark, Switzerland, Norway, Sweden, Spain, Finland, Austria, Netherlands, Belgium, Australia, Korea, Euro Area, United Kingdom, Portugal, Ireland, New Zealand- unemployment rate), Datastream, Bloomberg |
Long term expected inflation rate | The inflation expectations in 5–10 year or, alternatively, the objective of inflation of the central bank | Consensus (USA, Japan, Canada, Germany, France, Italy), Central Banks webpages (Denmark, Switzerland, Norway, Sweden, Spain, Finland, Austria, Netherlands, Belgium, Australia, Korea, Euro Area, United Kingdom, Portugal, Ireland, New Zealand) |
Core import prices | Annualized quarterly import prices rate-excluding fuel- | Bureau of Economic Analysis (USA), European Central Bank (Euro Area), ONS (United Kingdom), Minisitry of Economics (Japan), Oxford Economics (Canada, Germany, France, Italy, Denmark, Switzerland, Norway, Sweden, Spain, Finland, Austria, Netherlands, Belgium, Australia, Korea, Portugal, Ireland, New Zealand), own calculations |
Output gap | The difference between actual and potential GDP as a percentage of potential GDP | FRED (USA), Bank of Japan (Japan), Oxford Economics (Euro Area, United Kingdom, Australia, Canada, Denmark, Switzerland, Norway, Sweden, Korea, Germany, France, Italy, Spain, Ireland, Finland, Portugal, Austria, Netherlands, Belgium), WEO (New Zealand) |
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Berganza, J.C., Borrallo, F., del Río, P. (2018). Determinants and Implications of Low Global Inflation Rates. In: Ferrara, L., Hernando, I., Marconi, D. (eds) International Macroeconomics in the Wake of the Global Financial Crisis. Financial and Monetary Policy Studies, vol 46. Springer, Cham. https://doi.org/10.1007/978-3-319-79075-6_10
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