This year, headline inflation has averaged 1.7% in the US, 1.4% in the Euro-area, and 0.5% in Japan. Therefore, years after the financial crisis and despite, in many cases, low levels of unemployment, inflation is struggling to move to 2% – the magical target aimed at by central bankers. But struggle though they may, these bankers continue to strive. Most central banks have now signalled cuts are to come, yet what if the ‘true’ level of inflation of these economies is much lower – say 0.5% or 1%? This would mean that central banks are overstimulating the economies, which could well have weighty consequences…
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This year, headline inflation has averaged 1.7% in the US, 1.4% in the Euro-area, and 0.5% in Japan. Therefore, years after the financial crisis and despite, in many cases, low levels of unemployment, inflation is struggling to move to 2% – the magical target aimed at by central bankers. But struggle though they may, these bankers continue to strive. Most central banks have now signalled cuts are to come, yet what if the ‘true’ level of inflation of these economies is much lower – say 0.5% or 1%? This would mean that central banks are overstimulating the economies, which could well have weighty consequences.
Of course, there is no such thing as a ‘true’ level of inflation. All we have is history to guide us. Central banks spooked by soaring inflation in the 1970s probably looked back to the 2% inflation of the 1950s and 1960s and thought, why not return to the good old days? But why stop there? We could look even further back.
Analysing US data that stretches back to the 1800s, we find that between the 1800s and the 1940s inflation ranged from -3.5% to 7% (by decade, see chart). Notably, there were only three decades of inflation above 1%: the 1860s, 1910s and 1940s. Perhaps unsurprisingly, these are the decades that witnessed the US Civil War, World War I, and World War II.
The inflation of the 1970s was also linked in part to war, this time in Vietnam, but in addition it was supported by oil shocks, trade union power, and a liberalising international financial system. Since then, inflation has been falling every decade. Median inflation since 1800 turns out to be just under 1%. So perhaps we are simply reverting to the long-term average. What this means is that as long as central banks keep trying to push inflation towards 2%, then monetary policy will remain loose. And as we’ve seen in the years following 2008, the ensuing inflation will not be in the real economy. Rather, it will be in asset markets such as equities and credit.
Chart 1: US Inflation since the 1800s
Source: Nomura, Minneapolis Fed
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.
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