Central banks see what they want in ignoring deflation


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Janet Yellen, chair of the U.S. Federal Reserve, arrives to an open meeting of the Board of Governors of the Federal Reserve in Washington, D.C.

Federal Reserve Chair Janet Yellen and her international counterparts are suffering from a case of what psychologists call confirmation bias: They keep insisting inflation will accelerate even as it continues to ebb.
That’s the diagnosis of Ethan Harris, co-head of global economics research at Bank of America Corp. in New York. He says central bankers are seeing what they want to see by blaming subpar inflation in their countries on temporary, partly home-grown forces. That risks ignoring more lasting, global influences ranging from weak worldwide demand and more emerging-market competition to cheap labor in developing nations, cooling commodity prices and technological breakthroughs.
“There is much lower-than-expected inflation showing up in too many places in the world to dismiss it as transitory,” said Allen Sinai, chief executive officer at consultant Decision Economics Inc. in New York.
Almost two-thirds of the 121 economies tracked by Bloomberg are experiencing smaller gains in consumer prices than a year ago, with many undershooting their goals. Global inflation was just 2 percent in February, the lowest since late 2009, when the world was struggling with recession, according to a tally by economists at JPMorgan Chase & Co.
Investors are taking note. They have pulled $436.4 million out of exchange-traded funds tracking U.S. inflation so far this month, according to data compiled by Bloomberg.
Good news
While declining prices can be good news for consumers, disinflation makes it harder for borrowers to pay off debts and businesses to boost profits. The greater danger comes when disinflation turns into deflation, which leads households to delay purchases in anticipation of even lower prices and companies to postpone investment and hiring as demand for their products dries up.
The need to guard against such a risk means that even as advanced economies gain strength, Bank of America is anticipating the Fed will be slow to raise its benchmark interest rate from near zero. Its strategists predict this slowness will help lift the Standard & Poor’s 500 Index to 2,000 by year’s end from 1,872.18 (SPX) yesterday.
How much of a threat soft prices pose to the global economy will be discussed this week when central bankers and finance chiefs head to Washington for the annual meetings of the International Monetary Fund and World Bank. IMF Managing Director Christine Lagarde flagged the peril of prolonged ultra-low inflation in a speech last week.
Emerging risk
“There is the emerging risk of what I call ‘lowflation,’ particularly in the euro area,” which could suppress demand and output, she said in Washington.
The weak outlook for prices has companies such as Memphis, Tennessee-based car-part and accessory retailer AutoZone Inc. (AZO) tempering expectations for sales this year.
“There really hasn’t been significant inflation, and our view is that there won’t be significant inflation at least over the next six or seven months, which is about as far out as we can see,” Chief Financial Officer William Giles said at a March 5 investor conference. “It has had the impact of muting sales a little bit.”
Central bankers so far have argued that the shortfall in inflation is temporary.
“Some of the recent softness reflects factors that seem likely to prove transitory, including falling prices for crude oil and declines in non-oil import prices,” Yellen told lawmakers on Feb. 11.
Below target
Inflation, as measured by the personal-consumption-expenditures price index, has been below the Fed’s 2 percent target every month since May 2012 and stood at 0.9 percent in February, less than half the goal.
At their last meeting, on March 18 and 19, most Fed policy makers expected inflation would return to 2 percent in the next few years, according to minutes of the gathering released yesterday. A couple, though, voiced concern this might not happen.
European Central Bank President Mario Draghi blamed a dip in the region’s inflation rate to 0.5 percent last month partly on a late Easter, which depressed spending -- and prices -- for travel in March. Easter falls on April 20 this year; in 2013 it was March 31. He also cited a fall in energy prices.
The ECB has said it aims to keep annual price increases “below, but close to, 2 percent over the medium term.” It has missed that goal since the first quarter of last year, with March’s reading the lowest since October 2009 (ECCPEST), and Draghi said last week the ECB is debating forms of quantitative easing.
Retail Competition
In Canada, central-bank officials have said increasing retail competition contributed to an ebb in price pressures. Inflation fell to 1.1 percent in February, close to the bottom of the Bank of Canada’s 1 percent to 3 percent target.
U.S. merchants, including Wal-Mart Stores Inc. (WMT), Target Corp. (TGT), and Nordstrom Inc. (JWN), have expanded in Canada during the past year, while shoppers who live near the U.S. border are taking advantage of higher duty-free exemptions for trips south of the border.
Harris at Bank of America said such explanations miss the broader point that inflation is easing worldwide and probably will continue to do so. “The risk that inflation continues to fall is high,” he said.
The U.S. and other advanced economies still are saddled with excess capacity almost five years after the deepest recession since the Great Depression, making it difficult for companies to raise prices and workers to win wage increases.
Emerging-market growth
Growth in emerging markets, meanwhile, has slowed from its rapid pace at the start of the global recovery, dragging down commodity prices.
The end of an investment boom in China means producer prices there are extending their longest decline since 1999, and economists at New York-based JPMorgan predict consumer-price inflation will undershoot the official target for a third year. Price pressures also are easing in fellow developing nations.
Commodity prices have been cooling as growth in these economies slows and the U.S. finds new sources of fuel that allow it to become more energy independent. While the S&P GSCI Spot Index of 24 commodities has gained 3 percent this year, it’s down about 27 percent since its July 2008 peak.
“Structurally for most of the last two years, the trajectory of energy prices has been keeping prices down,” said Ebrahim Rahbari, a global economist at Citigroup Inc. in London.
Food-price rise
The exception to the price swoon has been agricultural commodities. A food-price index compiled by the United Nations rose 2.3 percent in March to its highest level in eight months. Unfavorable weather in the U.S. and Brazil and geopolitical tensions in Ukraine were behind the increase, according to Abdolreza Abbassian, senior economist for the UN’s Food and Agriculture Organization.
Some explanations for weakening worldwide inflation are more structural and driven by the growth of emerging markets, which Morgan Stanley estimates now account for half of the world economy, up from 37 percent toward the end of the 1990s. That’s handing global manufacturers a glut of cheaper labor and competition for their products, keeping prices in check.
The price of global manufactured goods fell in each of the last two years and dropped 2.9 percent in December, according to ABN Amro Bank NV. Meanwhile, a June 2013 paper by Loukas Karabarbounis and Brent Neiman at the University of Chicago Booth School of Business found that 42 of 59 countries exhibited downward trends in compensation as a share of national output between 1975 and 2012, showing how wages have been undermined as an inflationary force.
China’s loss
As China’s low-cost advantage has been eroded by rising labor costs, other locations, such as Vietnam and Bangladesh, are attracting investment in factories from Nike Inc. (NKE) and Samsung Electronics Co. (005930)
Technology also is contributing to the long-term price trend, according to economists at the U.S. research arm of Banco Bilbao Vizcaya Argentaria SA in Houston. The price of a mobile telephone has declined by 95 percent from $4,000 in 1982, while digital camcorders now cost 70 less than they once did, even though pixel counts rose from 580,000 to 3.8 million, economists Shushanik Papanyan and Kim Fraser wrote in a March 20 report.
“Our analysis points more toward a permanent shift in inflation trends for the long-term, particularly related to goods-producing sectors where technological advancements have improved productivity and cost efficiency,” they said.
Asset-bubble risk
For Stephen Jen, co-founder of London-based hedge fund SLJ Macro Partners LLP, the concern is that central bankers will keep eyeing inflation targets rather than inflation trends, risking asset bubbles by injecting stimulus to rally prices they have less control over than they think. Weak inflation is a shared burden given the increasing correlation of prices across nations since the mid-1990s, even though economic-growth rates are as disparate as they were in the 1970s.
“There may have been excessive fixation by central bankers on the levels of the consumer-price-index inflation measures, rather than the reasons behind these inflation trends,” Jen said.

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