"Nouriel Roubini: The Mystery of the Missing Inflation"

From CFI.co, Dec. 14:

Since the summer of 2016, the global economy has been in a period of moderate expansion, yet inflation has yet to pick up in the advanced economies. The question that inflation-targeting central banks must confront is straightforward: why?
 

Since the summer of 2016, the global economy has been in a period of moderate expansion, with the growth rate accelerating gradually. What has not picked up, at least in the advanced economies, is inflation. The question is why.

In the United States, Europe, Japan, and other developed economies, the recent growth acceleration has been driven by an increase in aggregate demand, a result of continued expansionary monetary and fiscal policies, as well as higher business and consumer confidence. That confidence has been driven by a decline in financial and economic risk, together with the containment of geopolitical risks, which, as a result, have so far had little impact on economies and markets.

Because stronger demand means less slack in product and labour markets, the recent growth acceleration in the advanced economies would be expected to bring with it a pickup in inflation. Yet core inflation has fallen in the US this year and remains stubbornly low in Europe and Japan. This creates a dilemma for major central banks – beginning with the US Federal Reserve and the European Central Bank – attempting to phase out unconventional monetary policies: they have secured higher growth, but are still not hitting their target of a 2% annual inflation rate.

“If a shock is temporary, central banks should not react to it; they should normalize monetary policy, because eventually the shock will wear off naturally and, with tighter product and labour markets, inflation will rise. ”

One possible explanation for the mysterious combination of stronger growth and low inflation is that, in addition to stronger aggregate demand, developed economies have been experiencing positive supply shocks.

Such shocks may come in many forms. Globalisation keeps cheap goods and services flowing from China and other emerging markets. Weaker unions and workers’ reduced bargaining power have flattened out the Phillips curve, with low structural unemployment producing little wage inflation. Oil and commodity prices are low or declining. And technological innovations, starting with a new Internet revolution, are reducing the costs of goods and services.

Standard economic theory suggests that the correct monetary-policy response to such positive supply shocks depends on their persistence. If a shock is temporary, central banks should not react to it; they should normalize monetary policy, because eventually the shock will wear off naturally and, with tighter product and labour markets, inflation will rise. If, however, the shock is permanent, central banks should ease monetary conditions; otherwise, they will never be able to reach their inflation target....MORE