The release of recent minutes of the FOMC deliberations on core interest rate rises indicates that, even if they decided to keep it out of the monetary policy statement, the committee members are concerned about the fact that inflation in the USA is not responding to the stimulants (GDP growth, falling unemployment, rising consumer confidence and so on) that would normally be calculated to make it head towards the 2% per annum level that is so beloved by economists the world over. It is currently hovering around 1.6% but there are real fears that it could go lower in the coming months.
The main driver of this tendency, of course, is the precipitate fall in the price of oil, and indeed of most other commodities. Even milk producers, despite the demand out of China, are feeling the pinch of falling prices from the processors. The decline in the price of oil has been exacerbated by the decision of Saudi Arabia not to cut production as a means of sustaining the price of crude. Their reasons for doing this are variously reported as being about a lack of confidence that other OPEC members will follow suit and therefore get a free ride at the Saudis' expense, to the idea that they can put pressure on US shale oil and gas producers by driving the price down to a level that is uneconomic for them. Perhaps the truth, as is so often the case, lies somewhere in the middle, and both of these things are factors.
Why the fear of low inflation?
The standard argument for a fear of low or negative inflation is that it causes would-be purchasers of big ticket items to delay their decision to buy, in the belief that they can get the item cheaper at some time in the future, thereby damaging economic growth, which depends on consumption.
The problem with this argument this time around is that, while the overall inflation figure in all developed economies is heading down, this is entirely due to one component of the measure, energy. All the others, food, alcohol and tobacco, non-energy industrial goods, and services, are still rising. This means that there is no disincentive to buy in regard to these categories. And even if there were, the rapid developments in technological innovation mean that price is no longer the main factor in people’s decision to purchase. Take motor cars for example – massive overcapacity in this industry some years ago meant that the manufacturers had to come up with innovations that would encourage purchases while trying to maintain profitability. And they did. Your average car salesman or woman is well up to this kind of challenge.
In the meantime, falling energy prices are a boon to consumers. Reflected in the prices of consumer goods, they encourage far more consumption, not less. And agitation for wage rises, which damaged business and caused untold disruption, is a thing of the past.
So what is it then, that makes the current bout of low price rises such an apparent problem for central bankers? The answer has to be debt. One thing that high inflation does is, it makes it a lot easier, over time, to repay loans. Money that was borrowed previously, when its value was higher, can be repaid with present day funds that have been devalued by inflation. In the 1970s, when there was rampant inflation, this was a wonderful thing for borrowers. Real interest rates, or the nominal rate less the rate of inflation, were negative for a long time.
And the world is now awash with debt. Governments are way over-borrowed, as are individuals. Banks are loath to make new loans until such time as they can deleverage, or get rid of the debt that is already outstanding.
Is this the real reason the powers-that-be in the economic world are so anxious to see average prices rise again?