March 7, 2016


Economic policymakers are at sea on inflation (Lawrence Summers, March 6, 2016, Washington Post)

Market measures of inflation expectations have been collapsing and, on the Fed's preferred inflation measure, are now in the range of 1 to 1.25 percent over the next decade. Inflation expectations are even lower in Europe and Japan. Survey measures have shown sharp declines in recent months. Commodity prices are at multi-decade lows, and the dollar has only risen as rapidly as it has in the past 18 months twice during the past 40 years when the value of the dollar has fluctuated freely. The Fed's most recent forecasts call for short-term interest rates to rise almost 2 percent in the next two years, while the market foresees an increase of only about 0.5 percent. Consensus forecasts are for U.S. GDP growth of only about 1.5 percent for the six months from October to this month. And the Fed is forecasting a return to its 2 percent inflation target on the basis of models that are not convincing to most outside observers. [...]

 In the 1970s, it took years for policymakers to recognize how far behind the curve they were on inflation and to make strong policy adjustments. Policymakers continued to worry about a supposed lack of demand long after it was an important problem. The first attempts to contain inflation were too timid to be effective, and success was achieved only with highly determined policy. A crucial step was the abandonment of the idea that the problem was structural in nature rather than driven by macroeconomic policy.

Today's risks of embedded "lowflation" tilting toward deflation and of secular stagnation in output growth are at least as serious as the inflation problem of the 1970s. They, too, will require shifts in policy paradigms if they are to be resolved. 

Posted by at March 7, 2016 6:22 PM