Mysterious inflation – have the well-known relations collapsed?

The American economy is recovering, as most macroeconomic indexes suggest. However, there is a standard posing quite a conundrum – the steadily low inflation. Despite all of that, monetary tightening still continues, however, the dynamics of the price increase are not expected to change significantly. Besides short-term effects, it is worth paying attention to long-term trends that alter inflation. Such factors can be the demographical changes, technological advancements, online trade, or the effects of sharing economy, and they can alter the inflation on several fronts.

Janet Yellen, chair of the Board of Governors of the Fed, said that inflation is a mystery, but it does not cross Fed’s plans, meaning that interest rate increase and central bank balance reduction will go undisturbed.

However, it is also worth wondering why the inflation aim has not been reached yet, especially that according to the forecasts, price increase remains below the 2% target in the coming years. The recent low inflation might reflect tendencies that could persist and be true to most developed countries.

DO CENTRAL BANKS FIGHT THE WARS OF THE PAST?

Inflation control has a long tradition of practice. There are numerous economic links that have been successfully applied up until now. However, even after the endeavours of the past years, inflation and pay rises are not going as expected. Meanwhile, everything is fine in the labour market or we could say that it is maybe even a bit too tight (a phenomenon completely the opposite of the stagflation of the 1970s).

Based on empirical experiences, the level of inflation is said to be the most accurate index of economic stability. When it comes to inflation control, mostly methods that are based on past experiences and were established in the past are used. These methods try to direct the economy to a stable and natural state. At times of economic decline, they load more money into the system, which is expected to increase emission, causing a chain reaction which in turn leads processes toward a more positive direction.  Simply put, if companies employ more workers, labour market becomes tighter, wages rise, which causes prices to increase.

However, the world changes, which means that the old models have to be revised; otherwise we might wage wars of the past.

LONG-TERM IN LOW INFLATION

Demographic changes are likely to play a part in the low inflation. Even though the labour market is tight, many of the baby boomers born after the Second World War are retiring, and the generation taking their place settles for lower wages. Furthermore, the society is ageing, which –  as we have seen in Japan –  leads to even lower inflation due to the decreasing demand, while labour market reserves are running out as well.

Technological development is also a significant factor – its impact made prices of commodities stagnate or caused deflation in the past decades. For example, we can buy safer and more economical cars for the fraction of the price they used to cost. The rate of development can also be seen in consumer electronics, accordingly to Moore’s law. Take smartphones, for example – they are absolutely ahead of computers that used to be considered advanced a couple of years ago, yet they cost significantly less. This improvement in development can be traced in industrial processes too since countless commodities can be produced at lower costs than years ago.

How these processes will be changed by the expansion of robotization and automatization is a question for the future – but they certainly have the potential to fundamentally reform labour market conditions.

Online trade and sharing economy can also set back price increases on many fronts. They improve price transparency and can make demand meet supply at lower costs, which facilitates lower prices. Just look at online accommodation booking sites or transport demand management companies.

According to a Goldman Sachs analysis, online company giants like Amazon can be made responsible for the persistently low inflation. In the USA, the majority of retail trade has established an online presence, where they try to attract more customers by offering free shipping.

These are just some highlighted changes that substantially transform economic laws. However, these are trends that – along with other impacts – economic operators have to take into account.